Congrats Randal Quarles on Financial Stability Board Appointment

Congratulations to Randy Quarles on his appointment to serve as Chair of the Financial Stability Board.

CFS is thankful for Randy’s early and constant support of our organization. As an Advisory Board Member and Trustee, he has been a source of wisdom on a wide range of topics. In particular, his involvement in “Bretton Woods: The Founders and Future” was especially productive and meaningful. The inspiration and encouragement from Randy will continue to guide CFS especially as we plan to honor the 75th anniversary of the birth of the international financial system and think strategically about the future.

See “Summary and Next Steps – Bretton Woods: The Founders and Future.”

Randy is uniquely experienced, remarkably learned, and thoughtful on virtually any monetary, regulatory, or related legal topic. Likewise, few to none are more honorable in character.

We wish him the best at the Financial Stability Board and continued success at the Fed.

Agencies Propose Changes to Volcker Proprietary Trading and Name-Sharing Restrictions

The FDIC, the Federal Reserve Board, the Office of the Comptroller of the Currency, the SEC and the CFTC (collectively, the “agencies”) proposed excluding certain community banks from the Volcker Rule. In addition, the proposal would permit a banking entity to share a name with a covered fund that it organizes and offers under certain circumstances. The proposal would amend the regulations implementing the Volcker Rule, consistent with the statutory amendments made pursuant to Sections 203 and 204 of the Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”).

Pursuant to Section 203 of the EGRRCPA, the proposal would exclude a community bank from the restrictions of the Volcker Rule if both of the following conditions are met: (i) it has total consolidated assets equal to or less than $10 billion, and (ii) its trading assets and liabilities are equal to or less than five percent of its total consolidated assets.

In addition, pursuant to Section 204 of the EGRRCPA, the proposal would allow a covered fund to share “the same name or a variation of the same name with . . . an investment adviser to the fund, subject to the conditions” that (i) the investment adviser is not, and does not share the same name as, “an insured depository institution, a company that controls an insured depository institution, or a company that is treated as a bank holding company”; and (ii) the name does not contain the word “bank.”

Comments on the proposal must be received no more than 30 days following its publication in the Federal Register.

CFS Monetary Measures for November 2018

Today we release CFS monetary and financial measures for November 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.0% in November 2018 on a year-over-year basis versus 4.1% in October.

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’

Federal Register: Banking Agencies Propose Updating Calculation of Derivative Contract Exposure Amounts

The Comptroller of the Currency, Federal Reserve Board and FDIC proposal allowing “advanced-approaches” banking organizations (i.e., those with $250 billion or more in total consolidated assets, or $10 billion or more in on-balance sheet foreign exposure) to use an alternative approach for calculating derivative exposures under regulatory capital rules was published in the Federal Register. Comments must be received before February 15, 2019.

As previously covered, the proposed approach – the standardized approach for counterparty credit risk (“SA-CCR”) – would replace the current exposure methodology (“CEM”). If adopted, the proposal would (i) require advanced-approaches banking organizations to use SA-CCR to calculate their standardized total risk-weighted assets by July 1, 2020 and (ii) allow non-advanced-approaches banking organizations to use either CEM or SA-CCR when calculating standardized total risk-weighted assets.

SEC Officials Highlight Requests to Improve ESG Disclosures and Arbitration Process

SEC Chair Jay Clayton and SEC Commissioner Kara M. Stein highlighted (i) the increasing number of investor requests for improved environmental, social and governance (“ESG”) disclosures, and (ii) the need to improve the arbitration awards process.

In remarks to the SEC Investor Advisory Committee, Mr. Clayton stated that the agency observed an increasing number of issuers disclosing ESG information and requests for ESG information by investors. He argued that (i) companies should focus on providing material disclosures that investors need in order to make informed investment and voting decisions and (ii) investors should also focus on each company’s specific circumstances.

Ms. Stein emphasized that certain investors believe it is critical to understand ESG matters to better evaluate a company’s performance. According to Ms. Stein, the reason that 43 percent of the shareholder proposals submitted during the last proxy season focused on ESG issues is because these investors believe there are “links between ESG matters and a company’s operational strength, efficiency, and management.”

As it relates to improving the arbitration process, Ms. Stein stated, even if a retail customer wins their arbitration after being harmed by a broker-dealer, the investor may not actually receive the damages award. Ms. Stein argued that enhancing the arbitration process is of great importance to retail investors and to broker-dealers who have not broken any rules. Mr. Clayton further stated that from the vantage point of a harmed investor, the ability to collect monetary damages from the wrongdoer is as important as the standard of conduct that our rules and regulations impose.

Lofchie Comment: As to Commissioner Stein’s observation that 43% of proxy requests were as to ESG matters, it is fair to ask “how many shares did those investors own”? and “were those investors motivated by concerns for the company, or did they have another agenda”? By way of example, PETA regularly participates in proxy contests. Its agenda is based on moral views regarding the treatment of animals, not on a desire for profit maximization; PETA is unlikely to advocate for investment in glue factories even if it were sure to double return on equity. Similarly, Chick-fil-A doesn’t close on Sundays to profit maximize. These are two examples of companies acting on certain moral values, which we may share, or not. If rectitude and profit maximization were just two sides of the same Roman coin, a camel could pass through the eye of a needle.

Novick on Financial Industry Transitions

Barbara Novick (BlackRock Vice Chairman and CFS Advisory Board Member) discussed financial industry transitions at the recent CFS Global Markets Workshop.

Presentation highlights include:

– Indexed equity strategies remain relatively small,
– Challenges of applying macroprudential tools to market finance,
– Potential risks to the US financial system from the future of Libor to bondholder rights to pension underfunding, among others.

For accompanying slides:

Don’t dismantle the post-crisis early warning system…

Greg Feldberg posted a thoughtful piece on the Office of Financial Research (OFR) – “Don’t dismantle the post-crisis early warning system.”  The OFR is a National treasure…and should be treated as such.

Greg covers much ground and is well informed as a former Senior Associate Director for Research at the OFR, Director of Research at the Financial Crisis Inquiry Commission (FCIC), and current Yale research scholar.

The perspective is well articulated.  I have a few remaining questions for Greg – such as his perspective on the relationship between FSOC and the OFR as well as the prior study on investment management.  Investment managers differ dramatically from banks.

I highly recommend the read –

Best,  Larry

Crisis Detection and Prevention

I discuss crisis detection and prevention based on experiences chairing an inter-agency crisis prevention group (while at the U.S. Treasury), working as a strategist on Wall Street, and advising a global macro hedge fund. The paper was published as a chapter in “The 10 Years After” the financial crisis volume published by the Reinventing Bretton Woods Committee.

My views differ from many recently offered.

I conclude with eight actionable ideas to improve crisis detection for investors and officials.

For full remarks:

CFTC Commissioner Quintenz Encourages China to Adopt U.S. Approach to Derivatives Markets

CFTC Commissioner Brian Quintenz described the role of derivatives in supporting economic growth, the advantages of the “principles-based” regulatory model of the U.S. derivatives markets and concrete steps China has taken to liberalize its financial markets.

In remarks at the 14th Annual China International Derivatives Forum, Mr. Quintenz disagreed with the label that derivatives are “risky,” stating that the derivatives present tools to manage and efficiently transfer risk to market participants who have the ability to bear it. He described derivatives as being vital to the “health and growth of a country’s real economy” and said that, as China’s derivatives markets grow, it should adopt an approach to futures market regulation akin to that taken by the CFTC.

He stated that participant diversity, customer protection, and market integrity promoted by principles-based regulation are three characteristics of the U.S. futures market that have contributed to “resiliency, vitality, and efficiency.” In particular, Mr. Quintenz added that:

  • the policy of open participation helped increase liquidity, which enables companies to engage with the market even during times of instability;
  • the legal regime supporting the U.S. futures markets leads to strong customer protections (i.e., the CFTC and exchanges “police the markets for fraud, abuse and manipulation”); and
  • a “principles-based approach” has numerous advantages over a “prescriptive approach” (i.e., principles-based regulation enables market participants to be “individually responsive to market dynamics”).

Mr. Quintenz explained that the growth of China’s futures markets has been critical to its economic rise. In particular, he cited recent incremental steps that have lowered barriers on the ability of non-Chinese entities to access Chinese financial markets.


Agencies Urge Banks to Pursue AML Compliance Innovation

Federal banking agencies urged banks to pursue innovative approaches to meeting Bank Secrecy Act/Anti-Money Laundering (“BSA/AML”) compliance obligations.

In a joint statement, the Federal Reserve Board, the FDIC, FinCEN, the National Credit Union Administration and the Office of the Comptroller of the Currency (the “agencies”) stated that innovation – including the use of artificial intelligence, digital identity technologies and internal financial intelligence units – has the potential to augment banks’ programs for risk identification, transaction monitoring, and suspicious activity reporting.

The agencies encouraged banks to test innovative programs, stating that a pilot program that fails, or a program that identifies suspicious activity that otherwise would have been overlooked, should not subject the bank to supervisory action, as long as the bank’s existing BSA/AML processes are adequate. According to the statement, FinCEN will consider requests for exceptive relief from BSA/AML regulations in order to facilitate the testing and potential use of new technologies and other innovations.

The agencies added that the implementation of innovative approaches to BSA/AML compliance will not result in additional regulatory expectations.

Lofchie Comment: The regulators’ joint statement may reflect an acknowledgment of the enormous expenses to which financial institutions have been put in complying with AML obligations and the fines that have been imposed for even unwitting failures to fulfill those obligations.