SEC Commissioner Peirce Criticizes “Mixed Messages” on Cryptocurrency

SEC Commissioner Hester M. Peirce expressed concern over the United States’ conflicting regulatory approach to cryptocurrency, stating that U.S. regulators are sending “mixed messages” to entrepreneurs. She encouraged the SEC to be less conservative in the approval process for crypto-exchange-traded products.

In a speech before blockchain entrepreneurs in Switzerland, Ms. Peirce stated that the U.S. regulatory environment likely is not giving crypto entrepreneurs a “welcoming impression.” According to Ms. Peirce, the U.S.’s “diffused financial regulatory system” leaves entrepreneurs unclear about which laws apply to their projects. Additionally, Ms. Peirce noted that regulators are not uniform in their approach to cryptocurrencies. For example, while the CFTC has approved crypto-derivatives markets, the SEC has not approved the application of any exchange-traded products based on cryptocurrencies or crypto-derivatives, she said.

In criticizing U.S. regulators’ “mixed messages,” Ms. Peirce also addressed the SEC’s recent hesitancy in approving crypto-exchange-traded products. Ms. Peirce encouraged the SEC to empower investors to make decisions about whether or not to invest in these products. Ms. Peirce urged the SEC to be more transparent, and to better explain the agency’s decision-making process for exchange-traded crypto-products.

Lofchie Comment: No doubt the SEC believes that crypto-investments are very risky and that they are saving investors, particularly retail investors, from making bad investments. If SEC Commissioners believe that the public offering of crypto-securities constitutes an “emergency” that justifies “aggressive” regulatory action, then, at a minimum, while the SEC stalls exchange-traded crypto products, it should seek legislation endorsing such authority. Presumably, if the authority were granted, it would be subject to limits and to procedural conditions, including the transparency sought by Commissioner Pierce. In the absence of such a Congressional grant of authority, the SEC should not seek to exceed its legislated powers. It is worth noting that the advantage of allowing public trading of crypto-securities is that it would facilitate short sellers coming in, which should serve to dampen prices (assuming that the short sellers agree with the SEC’s skepticism on valuations).

Banking Agencies Propose Community Bank Leverage Ratio

The Federal Reserve Board, FDIC and Office of the Comptroller of the Currency (collectively, the “agencies”) proposed a rule that would simplify capital requirements for qualifying community banking organizations that opt into a community bank leverage ratio (“CBLR”) framework. According to the agencies, the proposed CBLR framework is a “simple alternative methodology to measure capital adequacy” and would provide substantial regulatory relief to smaller banking organizations, consistent with Section 201 of the Economic Growth, Regulatory Relief, and Consumer Protection Act.

Under the proposal, a qualifying community banking organization would be defined as a depository institution or depository institution holding company that meets the following criteria:

  • total consolidated assets of less than $10 billion;
  • total off-balance sheet exposures of 25 percent or less of total consolidated assets;
  • total trading assets and trading liabilities of five percent or less of the total consolidated assets;
  • mortgage servicing assets of less than 25 percent of CBLR tangible equity; and
  • deferred tax assets from temporary differences that the institution could not realize through net operating loss carrybacks, net of any related valuation allowances, of 25 percent or less of CBLR tangible equity.

Banking organizations that elect to use the CBLR and maintain a CBLR of over nine percent generally would be exempt from complying with other risk-based and leverage capital requirements and would be considered to have met the “well capitalized” ratio requirements for purposes of Section 38 of the Federal Deposit Insurance Act.

Federal Register: FRB to Implement New Supervisory Rating System

The Federal Reserve Board (“FRB”) rule adopting a new supervisory rating system for large financial institutions was published in the Federal Register. The final rule is effective starting on February 1, 2019.

As previously covered, the FRB will enforce a new rating system for large financial institutions (“LFI”). The new LFI rating system will apply to (i) all domestic bank holding companies and non-insurance, non-commercial savings and loan holding companies (“SLHCs”) with $100 billion or more in total consolidated assets and (ii) U.S. intermediate holding companies of foreign banking organizations with $50 billion or more in total consolidated assets. The existing RFI/C(D) rating system will continue to be applied to community and regional bank holding companies with less than $100 billion in consolidated assets. In addition, the RFI/C(D) rating system will be expanded to apply to certain SLHCs with less than $100 billion in total consolidated assets on February 1, 2019.

CFS Monetary Measures for October 2018

Today we release CFS monetary and financial measures for October 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.1% in October 2018 on a year-over-year basis, maintaining the same growth rate as in September.

For Monetary and Financial Data Release Report:

For more information about the CFS Divisia indices and the data in Excel:

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’

SEC Commissioner Peirce Reexamines Financial Reporting and Securities Disclosure

SEC Commissioner Hester M. Peirce described potential problems with expanding SEC financial disclosures requirements to include “soft issues,” such as environmental, social and governance (“ESG”) information. According to Ms. Peirce, “financial reporting loses its value when it is applied too broadly.”

In remarks before the 2018 Leet Business Law Symposium at Case Western Reserve University School of Law, Ms. Peirce argued that requiring companies to disclose information that does not relate to the long-term financial value of the company may harm shareholders. Ms. Peirce stated that the current federal securities laws have traditionally interpreted “material” disclosure as information that demonstrates the likelihood of a company providing a return on an investment. She pointed out that the more money a company spends on disclosures (which is a costly process), the less is available for shareholders.

Ms. Peirce also explained that the disclosure process was not designed to accommodate many “soft issues.” First, financial disclosures are intended to provide “material” information for the “reasonable” investor. According to Ms. Peirce, requiring companies to disclose information that “responds to interests unrelated to the investment’s profitability” (i.e., ESG issues) would make the term “material” meaningless. Second, Ms. Peirce contended that ESG issues are often not easily definable and the auditing process is not reliable. By way of example, Ms. Peirce pointed to the International Accounting Standards Board’s recently released framework, which focuses on the ill-defined term “stewardship.”

Lofchie Comment: Compare and contrast Commissioner Peirce’s skeptical statement on ESG disclosure with Commissioner Stein’s supportive statement (see also Cabinet commentary here). There are tremendous benefits to this open dialogue and the fact that the two Commissioners have clearly articulated opposing views.

FDIC Chair McWilliams Analyzes Migration of Financial Activity from Banks to Nonbanks

FDIC Chair Jelena McWilliams outlined the risks and benefits associated with the migration of financial products and services from banks to nonbanks.

In remarks at the Finance, Law and Policy Fourth Annual Financial Stability Conference, Ms. McWilliams stated that a substantial migration of mortgage origination and servicing to nonbanks occurred since the last financial crisis. Ms. McWilliams noted that the nonbank migration will, among other benefits, help consumers by expanding access to the banking system, lowering transaction costs and increasing credit availability.

Ms. McWilliams stated that while these activities migrated to nonbanks, some of the risks remain with banks and could adversely affect the stability of the banking system. The FDIC reported that bank lending to nonbanks increased by 636 percent from 2010 to June 2018. The FDIC also found that, based on supervisory experience, nonbank mortgage originators receive funding from bank loans. She said that a similar trend can be seen in mortgage servicing where 60 percent of outstanding mortgage loans guaranteed by Ginnie Mae are serviced by nonbanks.

Ms. McWilliams also advised regulators and policymakers to consider the potential risks and benefits of nonbank financial activity. She stated that regulators should encourage banks to innovate, and added that banks will attempt to keep pace with nonbank technological and service developments.

Lofchie Comment: This answers the question of why nobody starts a new bank.  And why the price of NYC taxi medallions has crashed.  It’s the Uberization of financial services.

How do, and should, regulators respond?  More specifically from a regulatory standpoint, should the banking regulators consider whether regulations have made starting or maintaining a bank so unattractive from a business standpoint that the exodus from the banking industry becomes a material systemic risk? It’s not an easy question to answer; it’s not even remotely obvious how one would approach the question.  That said, if you have a political mindset that treats banks as inherently bad, this is the way the markets will go. And that might very well be ok, or even better, but politicians and regulators should be mindful of the direction of change and of the extent to which they are accelerating that change.

Sandor on “Creation and Evolution of New Markets: The Case of Interest Rate Benchmarks”

Dr. Richard Sandor – CFS Advisory Board Member and CEO of the American Financial Exchange (AFX) delivered remarks “Creation and Evolution of New Markets: The Case of Interest Rate Benchmarks” at a recent CFS roundtable.

Richard discussed the new Secured Overnight Financing Rate (SOFR) and American Interbank Offering Rate (Ameribor) – which is a new transaction-based interest rate based on actual overnight, unsecured transactions. As a perennial financial entrepreneur, his comments on LIBOR, financial innovation and the seven stages of market creation were especially noteworthy.

For the presentation:

For more on the AFX and Ameribor, please request a briefing pack from Rafael Marques at

SEC Commissioner Calls for New Enforcement Approach toward Compliance

SEC Commissioner Hester M. Peirce called on the SEC to consider alternative methods when addressing compliance infractions rather than resorting to enforcement proceedings.

In remarks at the National Membership Conference of the National Society of Compliance Professionals, Ms. Peirce stated that enforcement resources should not be used on relatively minor compliance infractions, but should be saved for more serious matters. Ms. Peirce advocated for a more “subtle” approach to resolving compliance infractions, such as building norms that foster compliance, as opposed to initiating “formal enforcement action[s].”

Commissioner Peirce expressed concern that actions directed against a compliance officer can have a “chilling effect” and adversely impact the compliance industry and profession. Ms. Peirce said that the SEC should not bring enforcement actions simply because it disagrees with a compliance officer’s judgment.

Commissioner Peirce also stated that a compliance examiner should help firms to pinpoint issues and, subsequently, work with them to correct those issues in an efficient as well as collaborative fashion without resorting to enforcement proceedings. Conversely, Ms. Peirce emphasized the importance of firms’ cooperation with SEC compliance staff and asserted that, too often, firms “drag their feet” or provide inaccurate information. According to Ms. Peirce, while the SEC’s Enforcement Division has a part to play in countering violations of securities laws, managers and employees at firms are the “first line of defense,” followed by compliance officers.

FRB Vice Chair Considers Proposed Amendments to Stress Testing Program

Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles considered proposed changes to the FRB’s large bank stress testing regime that would increase transparency and efficiency.

In a speech at the Brookings Institution, Mr. Quarles said that the FRB is seeking to improve the measurement of trading book-related risks, and that a “single market shock” approach in existing stress testing practice does not adequately capture risks in firms’ trading books. He said that the proposed changes “are not intended to alter materially the overall level of capital in the system or the stringency of the regime.”

Mr. Quarles discussed changes to the Comprehensive Capital Analysis Review (“CCAR”) indicating that the FRB will reconsider whether any part of the regulatory capital rule (the stress capital buffer or “SCB”) proposal will remain for the 2019 CCAR. He said that he intends to request that the FRB exempt firms with less than $250 billion in assets from the 2019 CCAR quantitative assessment and supervisory stress testing in light of the FRB’s recent tailoring proposal. In addition, Mr. Quarles expressed his support for “normaliz[ing] the CCAR qualitative assessment” by (i) removing the public objection tool and (ii) evaluating firms’ stress testing practices through “normal supervision.”

Mr. Quarles stated that elements of the proposal to integrate stress testing with the stress capital buffer will be amended after receiving public comment. As a result, the SCB, which was scheduled for the 2019 stress test cycle, will be delayed. Mr. Quarles said that the first SCB may go into effect after 2020.

SEC to Examine Operations of Certain Mutual and Exchange-Traded Funds

In a Risk Alert, the SEC Office of Compliance Inspections and Examinations (“OCIE”) provided information on a series of examination initiatives being conducted on industry practices and regulatory compliance of mutual funds and exchange-traded funds (“ETFs”) (collectively, the “funds”). The OCIE is interested in how the operation of these funds may impact retail investors.

The OCIE said it is investigating the following funds and advisers:

  • index funds that track custom-built indexes;
  • smaller ETFs and/or ETFs with little secondary market trading volume;
  • mutual funds with higher allocations to certain securitized assets;
  • funds with aberrational underperformance relative to their peer groups;
  • advisers who are relatively new to managing mutual funds; and
  • advisers who provide advice both to mutual funds and to private funds that (i) have similar strategies or (ii) are managed by the same portfolio managers.

The OCIE stated that it is evaluating whether the advisers’ and funds’ policies and procedures are designed to address risk and conflicts. The OCIE said it will examine disclosures and how the funds assess portfolio management compliance, and fund governance.

Lofchie Comment: It should be expected that the SEC will look closely at any situation where a public fund underperformed a private fund or managed account with a generally similar strategy. Any adviser who is managing clients that fit that description should carefully consider the reasons for the difference in performance.