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
A conference volume published by Palgrave Macmillan will be forthcoming.
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.
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:
Federal banking regulators testified before the U.S. Senate Committee on Banking, Housing and Urban Affairs on progress toward implementing the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Act”). As previously covered, the Act makes targeted changes to key areas of Dodd-Frank, which will primarily benefit smaller banking organizations with simpler business models. Testimony was provided by Comptroller of the Currency Joseph M. Otting; Federal Reserve Board (“FRB”) Vice Chair for Supervision Randal K. Quarles; FDIC Chair Jelena McWilliams; and National Credit Union Administration (“NCUA”) Chair J. Mark McWatters.
Mr. Otting, Mr. Quarles and Ms. McWilliams described various agency initiatives, including (i) the issuance of a notice of proposed rulemaking (“NPR”) that grants federal savings associations greater flexibility to exercise national bank powers without changing their charters, (ii) the issuance of a joint NPR to revise the statutory definition of a high-volatility commercial real estate exposure acquisition, development and construction loan, (iii) the adoption of interim final rules modifying the liquidity coverage ratio rule and (iv) the issuance of a joint agency proposal to raise the total asset threshold from $1 billion to $3 billion to allow well-capitalized insured depository institutions to be eligible for an 18-month examination cycle.
Mr. Otting noted that the Office of the Comptroller of the Currency also intends to:
- implement an exemption from appraisal requirements for certain rural real estate transactions;
- reduce the regulatory burden on banks for calculating and reporting regulatory capital;
- reduce reporting requirements on Call Reports;
- increase the required frequency of stress testing and reduce the required number of scenarios; and
- revise the leverage ratio requirements for the largest U.S. banking organizations.
Mr. Quarles stated that the FRB prioritized:
- issuing a proposed rule tailoring enhanced prudential standards for banks with assets between $100 billion and $250 billion;
- reviewing requirements for firms with assets between $250 billion and the globally systemic important bank threshold; and
- revisiting the threshold for the application of enhanced prudential standards to foreign banks.
Ms. McWilliams outlined the FDIC’s plans, which include:
- rule amendments to reflect the exemption for certain loans secured by real property;
- a proposed rule as to the community bank leverage ratio;
- updates to Call Report Instructions to reflect the reporting change from brokered to non-brokered treatment of specified reciprocal deposits; and
- reductions in reporting requirements for “covered depository institutions” with less than $5 billion total assets in the first and third quarter Call Reports.
Mr. McWatters discussed the NCUA’s recent actions and noted that the agency began to (i) update its examiner guidance and examination procedures, (ii) review credit union compliance in line with its risk-focused examination program and (iii) work with state supervisory authorities and other federal regulators to implement regulatory amendments.
Senator Bernie Sanders (D-VT) introduced legislation that would break up the biggest U.S. banking and financial institutions. The bill is sponsored in the U.S. House of Representatives by Representative Brad Sherman (D-CA).
The bill, titled the Too Big to Fail, Too Big to Exist Act, would, among other things, require:
- the restructuring of certain covered financial institutions (including banking organizations, insurance firms, broker-dealers and investment advisers) with a total exposure greater than three percent of the GDP of the U.S.;
- insurance companies with more than $50 billion in assets to report total exposure to federal financial regulators; and
- the Federal Reserve Board Vice Chair of Supervision and the Financial Stability Oversight Council to submit written reports on the status of financially significant institutions.
Entities that exceed the three percent cap (i.e., “too big to fail” institutions) would be given two years to restructure. According to the bill, these “too big to exist” institutions would not be eligible for a taxpayer bailout from the Federal Reserve Board and could not use customers’ bank deposits to engage in “risky financial activities.”
Lofchie Comment: Like some Cabinet newsletters, nice title, not much substance.
As the 10-year anniversary of the global financial crisis approaches, assessment of key events before, during, and since is essential for understanding varying dimensions of the crisis.
The CFS Financial Timeline, created and managed by senior fellow Yubo Wang, seamlessly links financial markets, financial institutions, and public policies. It:
- Covers more than 1,100 international events from early 2007 to the present.
- Provides an actively maintained, free, and easy-to-use resource to help track developments in markets, the financial system, and forces that impact financial stability.
- Curates essential inputs on a real time basis from established public sources.
Since 2010, the Timeline has become an integral part of the work done by scholars, students, government officials, and market analysts. View the Timeline.
We hope you find it of use and interest.
A three-judge panel of the U.S. Court of Appeals for the D.C. Circuit ruled in favor of the Loan Syndications and Trading Association (“LSTA”) in its litigation against the SEC and Board of Governors of the Federal Reserve System (“FRB”) over the application of risk retention rules to managers of collateralized loan obligations (“CLOs”).
The Court concluded that “open-market CLO managers” are not subject to the credit risk retention rules mandated under the Dodd-Frank Act, which require firms to hold 5% of their fund. The Court explained that because CLO managers are not “securitizers” under Dodd-Frank Section 941, managers have no requirement to retain any credit risk.
The LSTA, which represents participants in the syndicated corporate loan market, first sued the SEC and FRB in 2014. On December 22, 2016, the United States District Court for D.C. ruled against LSTA. In overturning that ruling, the Court of Appeals agreed with LSTA’s primary contention that “given the nature of the transactions performed by CLO managers, the language of the statute invoked by the agencies does not encompass their activities.”
If the decision stands, (i) managers of open market CLOs will no longer be required to comply with the U.S. Risk Retention Rules, (ii) there may be no “sponsor” of this type of securitization transaction needed, and (iii) no party may be required to acquire and retain an economic interest in the credit risk of the securitized assets of such a transaction.
Implementation of the decision reached by the Panel could be delayed, modified, or reversed if the SEC and FRB seek rehearing in the Appellate Court or petition the United States Supreme Court to accept the case.
In an op-ed published by Bloomberg, Senator Elizabeth Warren (D-MA) argued against any measures to reduce the regulation of banks with more than $50 billion in assets.
Senator Warren explained that Dodd-Frank mandates the Board of Governors of the Federal Reserve System (“FRB”) to impose stricter rules and apply more careful oversight to banks with more than $50 billion in assets. According to Senator Warren, the FRB has done a good job of “aggressively tailor[ing]” rules to ensure that banks with just over $50 billion in assets are not treated the same as banks with more than $250 billion in assets. This tailoring process is “ongoing,” and includes recent efforts to lower stress-testing requirements for banks with less than $250 billion in assets.
Senator Warren contended that big banks continue to advocate and lobby for raising the $50 billion threshold to $250 billion, or to have it replaced with a “multi-factor test.” She criticized both approaches, arguing that even banks at the lower end of the threshold pose significant risks to the financial system. Senator Warren posited that the correlated nature of these banks’ portfolios could lead to several of them failing at once. Lowering the threshold would only provide “negligible” benefit, she argued. Senator Warren suggested that changing the threshold would lead not to increased lending, but rather to “additional stock buybacks, mergers, and executive bonuses.”
Lofchie Comment: Senator Warren’s arguments might be more compelling if she tried to fit them more closely to particular facts or concerns. Because she chooses to argue in generalities, her claims have the appearance of generic political statements as opposed to attempts to discuss better financial regulation. As a result, the Senator remains consistent in her views on regulation: more is always better.
Given the authority that the Federal Reserve Board has over banks, it is an overstatement to suggest that banks might escape the Fed’s scrutiny. No one is suggesting that the Fed would not regulate bank holding companies. Further, the federal banking regulators have substantial authority over executive compensation and stock buybacks. That authority is not going to disappear. Lastly, it is not clear why Senator Warren believes that some reduction in regulation would lead to an increase in bank mergers. Heavy regulation results in increased fixed costs, which favors the very largest entities. One need not look far for proof. Since the adoption of Dodd-Frank, there has been increased financial industry consolidation (particularly in areas regulated by the CFTC, where the regulatory increases have been greatest; e.g., the number of FCMs is approximately halved).
Perhaps there are good arguments for maintaining the regulations that Senator Warren supports. If that is the case, Senator Warren would do better, to the extent that her interest is regulatory policy, to make those arguments with a good bit more specificity.
The U.S. Treasury Department (“Treasury”) released a second report pursuant to President Donald J. Trump’s Executive Order establishing core principles for improving the financial system (see coverage of first report). The new report details plans to reduce burdens of capital markets regulation (see also Fact Sheet on report).
The report recommends supporting and promoting access to capital markets, reducing regulatory costs, making changes to market structure and modifying derivatives regulation to facilitate risk transfer.
In a “Table of Recommendations” (beginning on page 205), Treasury lists proposed recommendations. Some highlights include:
- Public Companies and IPOs (e.g., decrease the cost of being a public company by eliminating the conflict minerals rule);
- Challenges for Smaller Public Companies (e.g., increase the level at which a company may be considered “small”);
- Expanding Access to Capital Through Innovation (e.g., allow accredited investors to invest freely in crowdfunded offerings);
- Maintaining the Efficacy of Private Markets (e.g., expand the definition of accredited investor);
- Market Structure and Liquidity, Equities (e.g., allow smaller companies to limit the exchanges on which they trade to facilitate the development of centralized liquidity);
- Market Structure and Liquidity, Treasuries (e.g., provide greater support for the repo market);
- Market Structure and Liquidity, Corporate Bonds (e.g., improve liquidity);
- Securitization and Capital (e.g., simplify capital regulation of banks);
- Securitization and Liquidity (e.g., treat certain securitizations as liquid assets);
- Securitization and Risk Retention (e.g., provide exemptions from the risk retention requirements);
- Securitization and Disclosures (e.g., reduce the number of required reporting fields for registered deals);
- Derivatives and Harmonization Between the CFTC and SEC (e.g., the SEC should adopt its security-based swap rules);
- Derivatives and Margin Requirements for Uncleared Swaps (e.g., there should be exemptions from initial margin requirements between bank affiliates of a bank “consistent with the margin requirements of the CFTC and the corresponding non-US requirements”);
- Derivatives and CFTC Use of No-Action Letters (e.g., rules should be fixed so it is not necessary to rely on no-action letters);
- Derivatives and Cross-Border Issues (e.g., the U.S. regulators should work with global regulators on issues such as privacy);
- Derivatives and Capital Treatment in Support of Central Clearing (e.g., required capital should be reduced on centrally cleared transactions);
- Derivatives and Swap Dealer De Minimis Threshold (e.g., there should be no reduction in the de minimis threshhold for dealer registration);
- Derivatives and Definition of Financial Entity (e.g., modify the definition, presumably with the goal of reducing the central clearing requirement);
- Derivatives and Position Limits (e.g., adopt rules but provide hedging exemptions);
- Derivatives and SEF Execution Methods and MAT Process (e.g., permit a broader range of trading mechanisms);
- Derivatives and Swap Data Reporting (e.g., improve standardization of reporting requirements);
- Financial Market Utilities (e.g., consider providing “Fed access” to certain clearing corporations);
- Regulatory Structure and Processes, Restoration of Exemptive Authority (e.g., restore the SEC’s and CFTC’s plenary exemptive authority under the statutes that they monitor);
- Regulatory Structure and Processes, Improving Regulatory Policy Decision Making (e.g., adopt clear rules);
- Regulatory Structure and Processes, Self-Regulatory Organizations (e.g., better define the roles of the SROs in rulemaking); and
- Internal Aspects of Capital Market Regulation (e.g., U.S. regulators should seek to reach “outcomes based non discriminatory substituted compliance arrangements” with foreign regulators to mitigate “the effects of regulatory redundancy and conflict”).
Lofchie Comment: The prior Administration viewed financial markets as creators of risk that had to be controlled; this Administration appears to view financial markets as creators of growth that would benefit from decreased controls. This is simply a tremendous difference in perspective and tone.
There will and should be a fair amount of discussion over these many and specific recommendations. One broad recommendation, however, stands out: restoring to both the SEC and the CFTC complete exemptive authority as to the requirements of the statutes that they enforce. Depriving the regulators of this authority in the wake of the Congressional enthusiasm for Dodd-Frank had limited the regulators ability to fix Congressional mistakes and over-reaches in drafting. The prior Administration had simply become so locked into defending Dodd-Frank against any criticism that it had become impossible for the regulators to consider, or even discuss, what aspects of it might be working or not. The new Administration does not bear the burden of justification.
The SEC Division of Economic and Risk Analysis (“DERA”) issued a report on how Dodd-Frank and other financial regulations have impacted (i) access to capital and (ii) market liquidity.
The report contains analyses of recent academic work, as well as original DERA analyses of regulatory filings. The report is divided into two major parts: “Access to Capital – Primary Issuance” and “Market Liquidity.” Highlights of the DERA report include the following:
Access to Capital – Primary Issuance
- Primary market security issuance has not decreased since the implementation of Dodd-Frank regulations.
- Capital from initial public offerings has “ebb[ed] and flow[ed] over time,” and the post-crisis downturn is “broadly consistent with historical patterns of IPO waves.”
- The introduction of the JOBS Act brought an increase in small-company IPOs, and “IPOs by [emerging growth companies] may be becoming the prevailing form of issuance in some sectors.”
- Regulation A amendments, including an increase in the amount of capital allowed to be raised, resulted in an increase in Regulation A offerings.
- JOBS Act crowdfunding provisions have allowed some firms to use crowdfunding to raise pre-revenue funds.
- The private issuance of debt and equity increased significantly between 2012 and 2016, and amounts raised through exempt offerings were much higher than those raised through registered securities.
- There is no evidence that the Volcker Rule has resulted in decreased liquidity, particularly with regard to U.S. Treasury Market liquidity.
- Trading activity in the corporate bond trading markets has tended either to increase or to remain static.
- The number of dealers participating in corporate bond markets has remained similar to pre-crisis numbers.
- Dealers have reduced capital commitments, which is in line with regulatory changes, such as the Volcker Rule, that “potentially reduc[e] the liquidity position in corporate bonds.”
- For small trades, transaction costs generally have decreased; DERA suggested that this might be due in part to the emergence of alternate trading systems as platforms for trading corporate bonds.
- For certain larger or longer maturity corporate bonds, transaction costs have increased since post-crisis regulatory changes.
DERA noted that it is difficult to quantify the effects of particular regulatory reforms, and that a variety of factors may contribute to market conditions.
Lofchie Comment: The conclusion reached by the Division of Economic and Risk Analysis – that there is no clear link between the Volcker Rule and decreased liquidity – contrasts sharply with the recent U.S. Treasury Report, which concluded that the rule’s “implementation has hindered marketmaking functions necessary to ensure a healthy level of market liquidity.” Similarly, a September 2016 study by FRB staff found that the Volcker Rule has had a “deleterious effect” on corporate bond liquidity. According to that study, dealers that are subject to Volcker requirements become less likely to provide liquidity during times of market stress.
Notably, DERA found that intraday capital commitments by dealers have declined by 68%. It is difficult to understand how a reduction in dealer inventory of this scale has no effect on liquidity. If that is really the case, then DERA should do more to identify the countervailing reasons that would explain the constancy of liquidity.