Basel Committee Oversight Body Approves Final Version of Market Risk Framework

The oversight body of the Basel Committee on Banking Supervision (“BCBS”), and the Group of Central Bank Governors and Heads of Supervision (“GHOS”), approved final revisions to the market risk framework. Separately, GHOS also approved the BCBS’s strategic priorities and work program for 2019.

The revised Minimum Capital Requirements for Market Risk replaced an earlier version published in January 2016. The January 2016 market risk framework, which was intended to enhance consistency of implementation, as well as lower arbitrage opportunities between capital requirements for market risk and credit risk, outlined the scope of application for market risk capital requirements. The revised market risk framework will become effective on January 1, 2022.

The revisions to the January 2016 market risk framework include:

  • a simplified standard approach to be used by banks that have smaller or non-complex trading portfolios;
  • clarifications as to the scope of exposures subject to market risk capital requirements;
  • improvements in the standardized approach to treatments of foreign exchange risk and index instruments;
  • changes to the standardized approach risk weights applicable to general interest rate risk and foreign exchange risk, as well as specific exposures subject to credit spread risk;
  • adjustments to the assessment process to determine whether a bank’s internal risk management models appropriately reflect trading risks; and
  • changes to the requirements for the identification of risk factors for internal modeling.

The BCBS maintains a two-year work program that outlines strategic priorities for its policy, supervision and implementation activities. The BCBS strategic priorities and work program for 2019 will focus on four central themes: (i) finalizing policy reforms and tackling new policy initiatives, (ii) assessing and monitoring the effect of post-crisis reforms, (iii) fostering strong supervision and (iv) ensuring the “full, timely and consistent implementation of the Committee’s post-crisis reforms.”

CFS Monetary Measures for December 2018

Today we release CFS monetary and financial measures for December 2018. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.6% in December 2018 on a year-over-year basis versus 3.9% in November.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Dec18.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’

FDIC Examines Bank Credit Risk Grading Systems

In its latest issue of Supervisory Insights, the FDIC Division of Risk Management Supervision (“DRMS”) reported that strong credit grading systems typically have “identifiable processes” and a “sound governance framework.”

The article, “Credit Risk Grading Systems: Observations from a Horizontal Assessment,” was drawn from examiner observations about the loan risk grading systems at certain state nonmember banks. The FDIC DRMS discovered that:

  • smaller institutions used “expert judgment”-based systems, in which a loan officer or relationship manager gives a grade based on his or her knowledge of the credit;
  • as banks grew bigger, management would switch from an expert judgment-based system to a quantitative scorecard or modeled approach consisting of qualitative adjustments;
  • certain institutions buy credit grading scorecard and statistical models from external vendors;
  • various institutions that depended on internal data were not retaining their “historical borrower information in a database or other centralized repository”;
  • certain banks were able to “assess grade accuracy well by comparing key borrower financial metrics and the internal grades across loans of a similar type”;
  • credit risk grading systems differ across the banking system;
  • risk grading can help in the implementation of the Current Expected Credit Loss accounting standard; and
  • efficient credit risk grading systems depend on timely and accurate data, among other things.

Regulators Encourage Lenders to Work with Consumers Impacted By Shutdown

In a joint press release, the Federal Reserve Board, the Office of the Comptroller of the Currency, the FDIC, the Consumer Financial Protection Bureau, the National Credit Union Administration and the Conference of State Bank Supervisors encouraged financial institutions to work with consumers impacted by the federal government shutdown. The agencies noted that affected borrowers may face hardship with regard to making payments on financial obligations, including mortgages, student loans, car loans, credit cards and other types of debt.

CFIUS and Silicon Valley: We’re Still Trying to Find a Cure!

CFS senior advisor Charlie Schott writes on new twists to the Committee on Foreign Investment in the United States (CFIUS).  While in government, Charlie’s group oversaw the Treasury-chaired inter-agency Committee.

CFIUS is the place where the United State’s commitment to an Open Investment Policy meets our most important national security concerns.

Early last August Congress passed the Foreign Investment Risk Review Modernization Act (FIRRMA), making significant changes to CFIUS.  The following article covers (1) what changes have been made by the new law and (2) what to expect with CFIUS going forward.

Who should be interested in these changes?  The short answer is Silicon Valley and financial market participants!

For the paper
http://centerforfinancialstability.org/research/CFS_Schott_1_10_19.pdf

President Trump Nominates Federal Housing Finance Director

President Trump nominated Mark Anthony Calabria to serve as Director of the Federal Housing Finance Agency (“FHFA”) for a five-year term.

Mr. Calabria is currently Chief Economist to Vice President Mike Pence. Before this role, he served as a senior aide on the U.S. Senate Banking Committee and helped draft the Housing and Economic Recovery Act of 2008. Mr. Calabria also served as Deputy Assistant Secretary for Regulatory Affairs at the U.S. Department of Housing and Urban Development under President George W. Bush.

If confirmed, Mr. Calabria will succeed outgoing Director Melvin Watt, who will depart at the conclusion of his term on January 6, 2019. President Trump designated Comptroller of the Currency Joseph Otting to serve as Acting Director of the FHFA until a successor to Mr. Watt is confirmed.

“Clean” Holding Company Requirements Now Fully Effective

The Federal Reserve Board’s (“FRB”) “clean holding company” requirements – which apply to the eight U.S. globally systemically important banks and the U.S. intermediate holding companies of the largest foreign banks operating in the United States – became effective on January 1, 2019. The requirements are applicable only to the legal entity that is the top-tier U.S. holding company and do not apply to its affiliates or subsidiaries.

According to the final rule adopted by the FRB, covered holding companies generally are barred from:

  • issuing guarantees of a subsidiary’s liabilities with cross-default rights regarding the covered holding company’s insolvency/resolution;
  • entering into qualified financial contracts with a third party;
  • providing short-term debt instruments to a third party; and
  • participating in upstream guarantees.

The prohibitions are applicable only to instruments or arrangements issued or entered into on or after January 1, 2019.

Finance Professor Says New Technology Not to Blame for Market Volatility

University of Houston Finance Professor Craig Pirrong rejected current conjecture that recent market sell-offs are due to technology, such as automated, algorithmic or high-frequency trading.

In a recent blog post, Professor Pirrong addressed concerns that increasing automation is responsible for a lack of liquidity during downturns, stating “by virtually every measure, the increasing automation in markets has led to greater liquidity.” Moreover, he asserted that the fact that market makers pull back from supplying liquidity during downturns is not unique to HFT; according to Professor Pirrong, this occurred in similar downturns “long before markets went electronic.” The same is true for so-called “momentum trading,” which Professor Pirrong said “is something else that long predates the rise of the machines.”

Because stock market movements are often unexplainable, large moves of an adverse nature often result in a “search for villains and scapegoats,” an exercise that, according to Professor Pirrong, is fruitless. He further noted that:

“[t]he bottom line is that the stock market sometimes decline substantially, without any obvious cause. Indeed, the cause(s) of some of the biggest, fastest drops remain elusive decades after they occurred. This is true across virtually every institutional and technological trading environment, making it less likely that any particular selloff is uniquely attributable to a change in technology. Furthermore, large market moves in the absence of any decisive event or piece of news is not inconsistent with market “rationality”, or due to some behavioral anomaly (which is inherently human, by the way).”

SEC Office of Investor Advocate Reviews FY 2018 Activities

The SEC Office of the Investor Advocate (“OIA”) identified “problematic products or practices” and summarized steps the agency and self-regulatory organizations took to respond to investor concerns during the past year.

In a “Report on Activities,” the OIA Investor Advocate identified “potentially problematic products or practices during Fiscal Year 2018” as reported by the SEC, NASAA, FINRA and the MSRB. These include, among others: (i) initial coin offerings, cryptocurrency and blockchain; (ii) a variety of scams and schemes (related to, e.g., regulator impersonations, Ponzi schemes, natural disasters and investments in “unicorns,” binary options, oil and gas, marijuana, microcap stocks and real estate, among others); (iii) cybersecurity; (iv) investment fees and expenses; (v) suitability of wrap fee programs; (vi) registrations of third-party providers, marketers and gatekeepers; (vii) a variety of risks (e.g., trading on margin, data aggregation, disclosure, and use of credit cards); and (vii) other practices (e.g., pennying and prearranged trading in connection with primary offerings).

In the report, the OIE focused on five key policy areas: public company disclosure, equity market structure, municipal market reform, accounting and auditing, and fiduciary duty.

On some of the broader policy questions, the OIA:

  • approved of the SEC’s current approach to ICOs, including its emphasis on the responsibilities of gatekeepers and others under securities laws;
  • encouraged FINRA to publicize the “data sets, models, and rankings” it uses to evaluate broker risk to help retail investors;
  • urged the SEC to prioritize reforming “outdated transfer agent regulations”; and
  • supported the continuing publication of investor education materials regarding the use of margin debt, although the OIA did not recommend any immediate regulatory changes.

Investor Advocate Rick A. Fleming recounted specific steps the OIA took to address investor concerns. The OIA:

  • requested additional research on the impact of proposed amendments to modernize public company reporting requirements;
  • collaborated with SEC staff and several SROs to “encourage equity market structure reforms designed to enhance market resilience, efficiency, transparency, and fairness”;
  • reviewed rulemaking proposals to reform the regulation of the fixed income markets and municipal securities markets;
  • supported the SEC’s proposed amendments concerning enhanced municipal securities disclosure under Exchange Act Rule 15c2-12;
  • provided feedback in response to MSRB’s draft amendments to rules on primary offering practices;
  • continued monitoring accounting and auditing standard setters:
  • urged the FASB to return to its earlier proposal for harmonizing its definition of materiality with “the courts, the SEC, and the PCAOB” due to investor concerns;
  • encouraged the SEC’s attention to problems regarding non-GAAP financial measures;
  • monitored developments with respect to auditor attention requirements;
  • sought internal and external feedback on accounting and auditing issues;
  • assisted the SEC in researching how proposed Regulation Best Interest would affect investors; and
  • submitted a comment supporting FINRA’s proposal to amend Rule 2111.

Mr. Fleming also stated that budgetary constraints affected some 2018 initiatives, including the agency’s failure to “build out” the Ombudsman role and certain research functions.