CFTC Commissioners Urge Bank Regulators to Change to Leverage Ratio Treatment of Cleared Derivatives

Four Commissioners of the CFTC urged U.S. banking regulators to amend the calculation of the supplementary leverage ratio in order to recognize client-posted initial margin in cleared derivatives. The Commissioners’ comments came in response to a rule proposal by the banking regulators to update the calculation of derivative contract exposure amounts under the regulatory capital rules, previously covered here.

In a comment letter, CFTC Commissioners Dan Berkovitz, Rostin Behnam and Brian Quintenz said that the banking regulators (the Federal Reserve Board, the FDIC and the Office of the Comptroller of the Currency) neglected to acknowledge the “risk-reducing impact” of client initial margin that the clearing member banking organization holds on behalf of clients. The Commissioners contended that a supplementary leverage ratio (“SLR”) calculation that permits initial margin to offset potential future exposures would eliminate an unnecessary impediment to banks offering client clearing services.

According to the Commissioners, the adoption of the standardized approach for counterparty credit risk (SA-CCR) without offset will:

  • “maintain or increase the clearing members’ SLRs by more than 30 basis points on average”;
  • continue to “disincentivize clearing members” from supplying clearing services; and
  • limit access to clearing in “contravention of G20 mandates and Dodd-Frank.”

Commissioner Dawn Stump recused herself from providing commentary on the proposed rule.

CFS Monetary Measures for January 2019

Today we release CFS monetary and financial measures for January 2019. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.4% in January 2019 on a year-over-year basis versus 4.2% in December.

For Monetary and Financial Data Release Report:
http://www.centerforfinancialstability.org/amfm/Divisia_Jan19.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’

OFAC Imposes Additional Venezuelan Sanctions

The U.S. Treasury (“Treasury”) Department Office of Foreign Assets Control (“OFAC”) designated five officials affiliated with “illegitimate former” Venezuelan President Nicolas Maduro, pursuant to Executive Order 13692. According to OFAC, these five individuals “continue to repress democracy and democratic actors in Venezuela and engage in significant corruption and fraud against the people of Venezuela.” The individuals include Manuel Salvador Quevedo Fernandez, the “illegitimate President” of Venezuela’s state-owned oil company, Petróleos de Venezuela, S.A.

Treasury stated that it may continue to sanction officials “who have helped the illegitimate Maduro regime repress the Venezuelan people.” As a result of OFAC’s action, all property and interests in property of the designated individuals subject to U.S. jurisdiction are now blocked, and U.S. persons generally are prohibited from engaging in any dealings with them.

New Papers on Lessons for the Future from the Global Financial Crisis

The Center for Financial Stability (CFS) was delighted to co-host a conference with the Central Bank of Iceland and the University of Iceland.

Leaders in academia, government, and finance from around the world joined together to present and discuss notable and pointed papers.  Held on the tenth anniversary of the Global Financial Crisis, discussions delved into crisis causes, the regulatory response, and lessons for the future.

Agenda and working papers can be found here
http://centerforfinancialstability.org/iceland.php

A conference volume published by Palgrave Macmillan will be forthcoming.

OCC Proposes Amending Company-Run Stress Testing Requirements

The Office of the Comptroller of the Currency (“OCC”) proposed amending the OCC’s company-run stress testing requirements for national banks and federal savings associations. The proposal is consistent with section 401 of the Economic Growth, Regulatory Relief and Consumer Protection Act. Comments on the proposal must be submitted by March 14, 2019.

The proposal would, among other things:

  • increase the minimum threshold for national banks and federal savings associations to conduct stress tests from $10 billion to $250 billion;
  • reduce the frequency with which certain banks would be obligated to conduct stress tests; and
  • cut the number of required stress testing scenarios from three to two.

SEC Commissioner Hester Peirce Describes Regulatory Challenges Posed by Cryptocurrency

In remarks at the University of Missouri School of Law, SEC Commissioner Hester Peirce described the difficulty in applying securities laws in general, and the Howey test in particular, to virtual currency and initial coin offerings. Ms. Peirce expressed concern that the SEC’s application of the Howey test will be “overly broad,” stating that token offerings do not always resemble traditional securities offerings. Some cryptocurrency projects may be unable to proceed because they cannot comply with applicable securities regulations, she said. In addition, she encouraged a “delay in drawing clear lines” for the regulation of virtual currency transactions which may provide more freedom for the technology to develop. Ms. Peirce noted that the SEC staff is working on “supplemental guidance” to “help people think through whether their crypto-fundraising efforts fall under the securities laws.”

Ms. Peirce stated that regulators tend to be unenthusiastic about innovation, given that it forces unwanted adjustments on them, as well as the possibility of negative consequences that are difficult to predict. The Commissioner said that the SEC must be open to innovation, given its potential to make our “lives easier, more enjoyable and more productive.” She raised a number of questions as to regulatory changes that might be considered in light of new technology; changing the ways in which firms communicate with their investors, for example, or revising the SEC’s recordkeeping rules.

Ms. Peirce also praised the SEC’s new office of “Small Business Capital Formation” and its first Advocate, Martha Miller.

Lofchie Comment: It’s a great thing when we have regulators who are thoughtful about the exercise of regulatory power, and are willing to weigh in a public forum the benefits and detriments of the use of that power. (I look forward, even if it requires quite a long look forward, to seeing her on late night television talk shows.)

Senator Elizabeth Warren Questions Federal Reserve Board on Bank Merger Approvals

In a letter to Federal Reserve Board (“FRB”) Chair Jerome Powell, Senator Elizabeth Warren (D-MA) raised questions about the FRB’s approval process for bank mergers and acquisitions (“M&A”). Ms. Warren first wrote to the FRB about its review of bank mergers in April 2018.

Ms. Warren voiced concern about FRB’s high rates of M&A application approvals. She also expressed concern about the FRB’s practice of allowing consultations between FRB staff and M&A applicants, which raise “questions about transparency and fairness.”

Ms. Warren’s letter was released after SunTrust Banks, Inc. and BB&T Corporation announced an agreement to merge, which would create the sixth-largest U.S. bank. Ms. Warren stated that the FRB’s record of “summarily” approving all M&A requests could have substantial impacts on consumer choice and competition.

Ms. Warren requested answers to her questions on the factors underlying increased bank M&A activity by February 21, 2019.

Lofchie Comment: Senator Warren’s concerns as to the percentage of bank merger applications that are approved totally misses the point, at least if the point is good financial regulation. If the regulators are (i) transparent as to what the standards are and (ii) consistent in the application of those standards, then it follows that a very high percentage of applications will be approved. Market participants know what the rules are. Conversely, if the regulators are opaque as to the standards, and if application of those standards is inconsistent (in other words, if the regulatory system is not working well), the percentage of applications approved may be much lower because the regulators are being more arbitrary in their exercise of power.

Senator Warren should focus on the standards by which approvals are granted and not on the percentage of applications granted.

CFPB Proposes Rescinding Provisions of Payday Lending Rule

The Consumer Financial Protection Bureau (“CFPB”) proposed rescinding the mandatory underwriting provisions of a final rule governing “Payday, Vehicle Title and Certain High-Cost Installment Loans.” Additionally, the CFPB proposed to delay the compliance date for the mandatory underwriting provisions of the final rule (originally August 19, 2019) until November 19, 2020.

The CFPB proposed to rescind:

  • the “identification” provision, which establishes that it is an “unfair and abusive practice for a lender to make covered short-term loans or covered longer-term balloon-payment loans without reasonably determining that consumers will have the ability to repay the loans”;
  • the “prevention” provision, which creates underwriting requirements for these loans to prevent the “unfair and abusive practice”;
  • the “conditional exemption,” for particular covered short-term loans;
  • the “furnishing” provisions, which obligate lenders who are making covered short-term or longer-term balloon-payment loans to “furnish certain information regarding such loans to registered information systems”; and
  • the parts of the recordkeeping provisions that are associated with the mandatory underwriting requirements.

The CFPB also proposed to rescind the Official Interpretations linked to these five provisions. Comments on the proposal to rescind the mandatory underwriting provisions must be submitted no later than 90 days following publication of the proposal in the Federal Register.

Comments on the proposal to delay the compliance date for mandatory underwriting provisions of the final rule must be submitted no later than 30 days following publication of the proposal in the Federal Register.

Lofchie Comment: The CFPB’s payday lending requirements seem intended as much to prevent payday lending by imposing regulations that are impractical to follow.  The policy question is whether this effective prohibition is good for those who actually need to borrow money or whether government’s protective or prohibitive policies hurt those whom it purports to help. This is not an easy question, but query whether the CFPB really tried to answer it before it adopted its anti-payday lending rules. See also CFPB Imposes Stricter Rules for Payday Lending.

Sargen: How Tariffs and China’s Slowdown Impact US Companies

As U.S. companies report fourth quarter earnings, a growing number have cited China’s slowdown as adversely impacting their businesses.  The most recent include industry bellwethers such as Apple, Caterpillar, and Nvidia.  In prior reports, multinationals such as Alcoa, Coca-Cola, Ford, GE, Harley-Davidson, and Whirlpool stated their earnings were being hit by higher tariffs on imports from China.

This list, moreover, is likely to grow if China slows further and/or tariffs on Chinese imports are increased.  However, this begs two questions: (i) Why is China’s economy softening; and (ii) Will the government be able to stabilize growth as it did in 2016?

One of the challenges investors confront is to assess whether China’s slowdown is primarily cyclical or secular.  Its growth rate has slowed steadily throughout this this decade, from about 10% in 2010 to 6.6% last year, the lowest in three decades.  In dissecting the recent slowdown, investors need to disentangle the effect of higher tariffs on Chinese imports from the impact of structural changes inside China.

There is general agreement that last year’s slowdown coincided with tariffs being imposed on 10% of Chinese goods imported to the U.S. during the first half of 2018.  The economy weakened further in the second half, when the list was extended to cover one half of imports from China.  Accordingly, investors believe a resolution of the trade dispute is critical to stabilize China’s economy.

Beyond this, China’s potential growth rate is decelerating for structural reasons. The country’s economic miracle was founded on agricultural workers in rural areas migrating to urban areas along the coast with higher-productivity manufacturing jobs.  But this process has become more challenging as wages in manufacturing have increased and unit labor costs have surged. Consequently, some economists believe China confronts a “middle income trap.”

Amid declining productivity growth, China’s government has relied increasingly on fiscal stimulus and credit expansion to achieve its growth target of 6.0%-6.5%.  But this has also resulted in a doubling of China’s overall debt burden from about 150% of GDP before the GFC in 2008 to 300% currently.  The problem with this strategy is it is not viable, as more and more credit is required to support each unit of output.  The reason: Much of the credit expansion has gone to SOEs, some of which the IMF labels as “zombies” – or firms that pile on debt but do not contribute positive value added.

Faced with this predicament, China’s policymakers pursued several measures last year to bolster the economy.  They included lowering short term interest rates by more than 200 basis points, allowing the yuan/dollar exchange rate to decline by 10%, while also expanding credit and lowering tax rates.  Similar actions were undertaken during China’s slowdown in 2015-2016, which proved effective in bolstering the economy.

Thus far, however, their impact is not readily apparent.  Auto sales, for example, declined in November by nearly 14% over a year ago, and Apple’s recent public filing indicated softness in consumer spending on electronics.  China’s imports plummeted in December, and exports also appear headed for a fall based on recent purchasing manager surveys and weakness in Asia and Europe.

What is clear is China’s policymakers are prepared to take additional actions to keep economic growth above the 6% threshold.  The central bank, for example, announced a one percent reduction in reserve requirements, and the government is boosting spending and lowering taxes. What is unclear is whether such action will be as effective as in the past due to the country’s rising debt burden.

The wildcard is whether an agreement on trade can be reached by the March 1 deadline.  While both sides wish to do so, the underlying issues are complex.  If the disagreement were simply about the size of the bilateral trade imbalance, the issue would be resolved, as China is willing to boost imports from the US and could direct SOEs to do so. However, the more difficult issues relate to violations of intellectual property and subsidization of businesses by the Chinese government, which the US opposes.

The most likely outcome is a temporary truce will be reached, which would bolster world equities for a while.  However, because a lasting agreement is harder to achieve, officials may in effect opt to “kick the can down the road.”

The outcome will have an important bearing on global economies.  While the US economy has withstood the impact of China’s slowdown thus far, a growing number of US companies are feeling the impact as noted previously. Furthermore, there has been a significant downward revision to earnings expectations by Wall Street analysts over the past six months. They are now calling for S&P 500 EPS growth of 8.1% in 2019 from more than 20% last year.  Yet, some observers believe the results will be weaker.

Ultimately, the market’s outcome will depend on whether China’s slowdown can be arrested by policy action.  If so, equity markets are likely to rally.  If not, they are likely to stay volatile, as the impact of a permanent slowdown has not been priced into markets.

UK and EU Securities Regulators Agree to Cooperate in Event of No-Deal Brexit

The Financial Conduct Authority (“FCA”), the European Securities and Markets Authority (“ESMA”) and other EU securities regulators agreed to two Memoranda of Understanding (“MoUs”) regarding the activities of credit rating agencies, trade repositories and asset managers. These MoUs would be effective only if UK and EU authorities fail to reach an agreement over Brexit.

The multilateral MoU with the FCA, the EU and European Economic Area (“EEA”) National Competent Authorities (i) includes “supervisory cooperation, enforcement and information exchange” and (ii) allows the regulators to access information on, “amongst others, market surveillance, investment services and asset management activities.” The MoU allows certain activities, such as fund manager outsourcing and delegation, to continue to be carried out by UK-based entities on behalf of counterparties based in the EEA. For the funds industry, the MoU provides certainty to firms that delegate fund management to UK asset managers.

The MoU, with the FCA and ESMA, concerns information regarding the supervision of credit rating agencies and trade repositories. The MoU paves the way to allow EU counterparties to continue using those trade repositories.