Going beyond the news, CFS Senior Fellow Steven Lofchie adds his insights, analysis and commentary on financial regulation from the view of a practitioner. Steve’s daily updates cover topics such as the most recent changes in Dodd-Frank rulemaking, bank and non-bank regulation, cross border developments, futures and swaps regulation, systemic risk issues, and tri-party repo.
The U.S. Senate Banking Subcommittee on Economic Policy considered testimony on the benefits of issuing a central bank digital currency (“CBDC”).
Subcommittee Chair Senator Elizabeth Warren (D-MA) expressed support for a “well-designed” and “efficiently executed” CBDC because of its potential to “drive out bogus digital private money while improving financial inclusion, efficiency, and the safety of our financial system.” By contrast, Ms. Warren criticized cryptocurrencies, calling them a “fourth-rate alternative to real currency” and asserting that they are:
a “lousy” means of transacting, since their value substantially fluctuates as a result of speculative day trading;
a poor investment, given that there are currently no consumer protections for crypto investors, and pump-and-dump schemes “have become routine in crypto trading”;
substantial facilitators of illegal activity, as the secrecy component of cryptocurrencies has enabled criminals to more easily move money; and
“staggering” consumers of energy; she pointed to (i) the amount of energy required in “proof-of-work” mining for new cryptocurrency tokens, and (ii) the fact that Bitcoin-related energy consumption is higher than the yearly energy consumption of the Netherlands.
The Subcommittee heard testimony from the following individuals:
Dr. Neha Narula, MIT Digital Currency Initiative Director. Ms. Narula testified that a CBDC is not the only method for addressing the issues associated with underbanking in the traditional financial system, noting that a requirement on banks to provide free, no-minimum accounts to users might address the issue. Considering that the U.S. dollar plays a significant role in the global economy, Ms. Narula cautioned against too quickly adopting a U.S. CBDC without thoroughly determining (i) how it should be accessed and managed, and (ii) what data it makes visible, to whom and under what circumstances.
Lev Menand, Columbia Law School Academic Fellow and Lecturer in Law. Mr. Menand described shortcomings of the current U.S. banking system, including: (i) inaccessibility for certain U.S. households, (ii) the high cost of overdraft, deposit and minimum balance fees, (iii) slow processing times for check deposits, wire transfers and credit card payments, and (iv) complexity with respect to differing bank ledgers. Mr. Menand stated that the advent of a CBDC could address these shortcomings by, among other things, (i) expanding mainstream banking eligibility, (ii) decreasing the clearing time for payments, (iii) reducing the fees associated with banking, (iv) enhancing financial stability for businesses and institutions, and (v) decreasing regulatory complexity, considering that many of the regulations promulgated following the 2008 financial crisis were aimed at deposit substitutes.
Dr. Darrell Duffie, Stanford University Graduate School of Business Professor of Management and Finance. Mr. Duffie urged the United States to invest in the development of a CBDC, considering the progress that has been made internationally in similar ventures, particularly that of China’s eCNY. Mr. Duffie recommended that the United States (i) “take a leadership position” in international conversations regarding the cross-border use of CBDCs, and (ii) enhance the competitiveness and efficiency of the existing U.S. payment system.
J. Christopher Giancarlo, Willkie Farr & Gallagher Senior Counsel. Mr. Giancarlo promoted the Digital Dollar Project’s “champion model” proposal for a CBDC, which would involve the Federal Reserve issuing “Digital Dollars” to regulated banking entities. The former CFTC Commissioner stated that the champion model would enable the continuation of the two-tiered commercial bank and regulated money transmitter model through its deployment and recording of the Digital Dollar transition on a “new transactional infrastructure informed by distributed ledger technology.” Mr. Giancarlo asserted that the Digital Dollar would be “far superior” to Bitcoin with respect to environmental sustainability because it would not have to be mined. Rather, the Digital Dollar would be created by the Federal Reserve cryptographically and distributed electronically. Additionally, Mr. Giancarlo contended that the existence of a Digital Dollar during the earlier stages of the COVID-19 crisis would have provided a means of instant monetary relief to targeted beneficiaries. Mr. Giancarlo also noted that a Digital Dollar could be superior to competing financial instruments of foreign jurisdictions, particularly those with anti-democratic regimes that could use those instruments for surveillance purposes. He explained that it would be “in the best national interest of the United States and . . . in the interest of the world economy” to create a well-designed U.S. CBDC. One challenge, Mr. Giancarlo observed, is the ability of the United States to take a leadership role in the innovation of a CBDC, considering that “this global wave of digital currency innovation is quickly gaining momentum.”
A U.S. dollar CBDC seems inevitable. When Senator Warren and former CFTC Chair Giancarlo agree on something, on anything, it is probably time to act. At what point does continuing to conduct studies create delays that may weaken the competitive position of the dollar in the global economy (or at least fail to capitalize on its strengths)?
Investors and the public are right to worry about inflation. Yet, measures to predict the impact of Fed policies on inflation, the economy, and financial stability are of deteriorating quality and being disregarded.
Market participants and especially officials must recognize that quantities of money matter now more than ever. Gyrations of the Fed’s balance sheet are at heights not witnessed in over 100 years.
Here, the Fed is moving in the opposite direction of its Congressional mandate (Section 2A) by increasing the money supply far in excess of long-run growth.
Since 2012, the Center for Financial Stability (CFS) has offered the public alternative monetary measures – pioneered by Professor William A. Barnett.
From this work, we now know that measuring activity in the financial system better predicts both inflation as well as financial instability risks.
The U.S. House of Representatives passed a bill that would direct the CFTC and SEC to jointly create a digital assets working group.
The bill would require that the working group include at least one individual representing each of the following groups: (i) financial technology firms providing digital assets products or services; (ii) financial firms within the jurisdiction of the SEC or the CFTC; (iii) institutions or organizations conducting academic research or engaging in advocacy efforts concerning the use of digital assets; (iv) small businesses using financial technology; (v) organizations concerned with investor protection; and (vi) institutions and organizations advocating for investment in historically underserved businesses.
Additionally, the bill would require that, within a year of its enactment, the working group must submit a report to the SEC, the CFTC and “relevant committees” that includes, among other things, an analysis of:
the United States’ legal and regulatory framework concerning digital assets, including the effect of (i) the ambiguity of the framework on primary and secondary digital assets markets, and (ii) domestic legal and regulatory digital assets regimes on the “competitive position of the United States”;
recommendations regarding (i) the implementation, maintenance and enhancement of primary and secondary digital assets markets, including the improvement of “fairness, orderliness, integrity, efficiency, transparency, availability and efficacy” of those markets, and (ii) standards for custody, private key management, cybersecurity and business continuity as it pertains to digital asset intermediaries; and
best practices to (i) decrease the prevalence of digital assets fraud and manipulation in cash, leveraged and derivatives markets, (ii) enhance investor protections for participants in such markets and (iii) aid in compliance with the Bank Secrecy Act’s AML anti-terrorism financing provisions.
Why is it necessary to have the SEC and CFTC conduct a joint study, with each naming the same number of members? Would it not make more sense to empower one agency (generally the SEC) and direct it to consult with other agencies, including the CFTC and, for example, FinCEN, if AML is a topic of concern?
Second, explicit directions as to the members of the joint study detract from the efficacy of the study. Do the legislators believe that because one financial firm – subject to the regulation of the SEC – is included in the study, that firm can speak on behalf of all the other regulated financial firms?
Third, the topics seem to be a grab bag of wholly unrelated issues: is there some link between digital custody and historically underserved businesses where the same committee members will bring value to both discussions? If so, it is not obvious. If Congress wants both issues (or any of these issues) studied, it should direct the SEC to conduct the studies, and let the SEC figure out how to do so.
The Congressional Research Service (“CRS”) reviewed the role that “payment for order flow” (“PFOF”) plays in the “surge in retail investor securities trading at major discount broker-dealers.”
In its report, CRS described PFOF as a controversial rebate subsidizing the “non-existent commissions.” CRS stated that when broker-dealers do not pass the PFOF rebates onto clients, the economic incentives to send retail orders to rebating market-makers create potential conflicts of interest. CRS noted that this argument is why the United Kingdom has “effectively banned” PFOF.
Advocates for PFOF argue that investors benefit from the subsidized low or zero commission rates. Critics argue that PFOF raises conflicts-of-interest concerns over a brokers’ duty of best execution.
While payment for order flow is a legitimate area for discussion, the more significant issue is why customers don’t use full-service brokers that provide them with some level of guidance. Congress and the SEC should consider whether over-regulation and the threat of enforcement actions are killing the business of full-service brokerage, leaving retail customers essentially on their own.
Unfortunately, asking the question as to whether regulation may be excessive or have unintended consequences is not a current priority. Rather, the tendency in response to any unusual event is to seek to adopt more regulations, as if more rules are always the panacea. Whether or not payment for order flow survives, the more significant reality is that retail investors are now effectively pushed to obtain their investment advice not from a regulated institution, but from a subreddit. See generally GameStop: Regulators Should Focus Less on “Solving the Problem”; More on “Improving the Situation.”
CFS Board Member and former FDIC Chair Sheila Bair and I note how:
Conservatives accuse progressives of wanting to destroy capitalism. Yet a greater threat than Bernie Sanders is the prospect of serial market bailouts by monetary authorities.
The creation of the corporate facilities last March marked the first time in history that the Fed would buy corporate debt. The plan went far beyond previous quantitative easing.
– There is not much evidence that all of that cash went toward creating and preserving jobs in the U.S. – Corporate facilities merely intensified the damage that monetary interventions had already dealt to U.S. capital allocation.
Capitalism doesn’t work unless capital costs something and markets don’t work unless they are allowed to rise and fall. Corporate facilities should not become part of the Fed’s standard tool kit. Let them die.
A subcommittee of the CFTC Market Risk Advisory Committee (“MRAC”) recommended that U.S. regulators take action to address the risks that climate change poses to the U.S. financial system.
The recommendations came in a report, titled Managing Climate Risk in the U.S. Financial System, issued by the MRAC Climate-Related Market Risk Subcommittee. CFTC Commissioner Rostin Behnam, the sponsor of the MRAC, suggested the report could be used by “policymakers, regulators, and stakeholders” to begin a process of “taking thoughtful and intentional steps toward building a climate-resilient financial system that prepares our country for the decades to come.”
The report presents 53 recommendations to mitigate risks to financial markets posed by climate change and concludes, among other things, that:
climate change poses a “major risk to the stability of the U.S. financial system and to its ability to sustain the American economy”;
regulators “must” recognize that climate changes poses “serious emerging risks” and should move “urgently and decisively to measure, understand, and address these risks”;
existing law provides U.S. financial regulators with significant authority that could be used to begin addressing financial climate-related risk;
regulators can help promote the role of financial markets as providers of solutions to climate-related risks; and
financial innovation is required to manage climate risk and to facilitate the flow of capital in order to help “accelerate net-zero transition and increase economic opportunity.”
The report was approved 34-0 by the subcommittee’s membership. The CFTC also posted statements from participants on the subcommittee: (1) Cargill, (2) Citi, JP Morgan and Morgan Stanley, (3) CME Group, (4) ConocoPhillips and (5) Vanguard.
The job of the CFTC is to regulate markets in which market participants can agree to transfer risk between them. If there exists a sufficient number of market participants to create a liquid market in which they can buy and sell “climate risk,” such risk would be measured by these participants. Then the CFTC should do its best to regulate that market so that it operates efficiently and transparently. It is not the job of the CFTC, as a regulatory agency, to advocate as to carbon taxes (either for or against), or for that matter, local insurance markets, corporate disclosures, or corporate governance. That job is entrusted to other regulators. When regulators pursue these other objectives, they deviate from their mission and their real task.
With the NFL football season now upon us, it is appropriate for the CFTC to consider the words of the greatest football coach of all time: “Do Your Job.”
The CFS Financial Timeline, created and managed by senior fellow Yubo Wang, is likely the longest continuous financial timeline freely available. It covers over 1,300 international events from early 2007 to the present. The timeline curates essential inputs from established public sources to seamlessly link financial markets, financial institutions, and public policies.
The CFS Financial Timeline has become an integral part of the work done by scholars, students, government officials, and market analysts, who seek to:
Uncover relationships among market reactions, institutional activities, and public policies
Accurately analyze developments, in one place, as they happen,
Put current events in a historical context, and gain insights on future developments.