FRB Governor Powell Describes Challenges to Real Time Payment Systems and Blockchain Technology

Federal Reserve System Governor (“FRB”) Jerome Powell described the challenges and policy objectives behind (i) the creation of a real-time retail payment system, (ii) the use of distributed ledger technology for clearing and settlement services, and (iii) the issuance of digital currencies by central banks.

In an address before the Yale Law School Center for the Study of Corporate Law, Governor Powell criticized the sluggishness of the U.S. payment system. He stated: “our traditional bank-centric payments system, sometimes operating on decades-old infrastructure, has adjusted slowly to the evolving demands for greater speed and safety. Innovators have built new systems and services that ride on top of the old rails but with mixed results, and over time, our system has grown more fragmented.” Arguing that “it will take coordinated action to make fundamental and successful nationwide improvements,” Mr. Powell said that efficiency and safety were the FRB’s primary objectives regarding the development of a faster payment system utilizing real-time payments (see FRB Policy on Payment System Risk). Mr. Powell highlighted some of the work being done by the FRB Faster Payments Task Force, which recently completed reviews of 19 faster payment proposals.

On the use of DLT and blockchain technology, Mr. Powell noted recent developments and collaborations between banks and market infrastructures, including plans to use DLT by a few major U.S. clearing organizations. However, Mr. Powell observed that:

  • the financial industry has focused on the development of systems that require permission for access to ledgers, functions or information, rather than the open access system contemplated by Bitcoin;
  • firms are still trying to determine the business case for upgrading and streamlining payment, clearing, settlement, and other functions related to DLT;
  • technical issues – including issues of reliability, scalability, and security – remain unresolved;
  • governance and risk management will be “critical” to the success of DLT; and
  • the legal foundations supporting DLT, including jurisdictional issues, need more attention.

Mr. Powell also discussed the prospect of central banks issuing digital currencies. He cautioned that major technical and privacy challenges, as well as competition with private-sector products, might “stifle innovation over the long run.”

New Trucking Futures and Options Exchange to Launch

Risk Desk editor John R. Sodergreen interviewed former ICE eConfirm Chief Bruce Tupper and former CFTC attorney Peter Kavounas about the prospective launch of a trucking futures and options exchange. The new exchange, TransVix, is intended to serve the risk management needs of the trucking industry.

Mr. Tupper explained that the trucking market involves a limited number of pre-set routes, or “origin-destination” pairs, with seasonality data trends resembling those of the gas pipeline network and also similar in concept to the electricity market. He stated that the trucking market has “a perishable commodity, one you can’t really store and [one that] has so many potentially precipitous impacts” that are difficult to predict and hedge against. He said that the trucking industry experiences greater price volatility than the energy markets because “shippers here can move a lot of their fleet into a market that might be overpriced at the moment, and take advantage of those rates, then bring it back down.” Mr. Tupper also predicted that there “should be a very good spot market from the beginning” and said that TransVix eventually “will offer an 18-month curve to capture a year’s worth of seasonality.”

In addition, Mr. Tupper mentioned that TransVix intends to partner “with an established clearing operation to bring these contracts to market.”

SEC Acting Chair Piwowar and Commissioner Stein Face Off on Regulation Crowdfunding

The SEC Division of Economic and Risk Analysis and the NYU Salomon Center for the Study of Financial Institutions hosted a “dialogue” on Regulation Crowdfunding. The dialogue focused on three aspects of securities-based crowdfunding: the “economic rationale and legal framework; investor protection and capital formation; and the [related] empirical evidence and data.”

SEC Acting Chair Michael S. Piwowar stated that Regulation Crowdfunding “permits retail investors to be solicited to purchase unregistered securities of small private companies.” He asserted that this is a “fundamental alteration of nearly 80 years of U.S. securities law practice.” He also reported a determination by SEC staff:

“To date, 163 U.S. securities-based crowdfunding deals have been initiated, of which 33 have completed their fundraising. Over $10 million has been raised since the regulation went into effect, with most offerings still ongoing.”

Acting Chair Piwowar expressed concern that the final Regulation Crowdfunding requirements might be “too restrictive or too burdensome.” He urged the SEC to “consider whether any further steps should be taken to improve our crowdfunding regulations, including the use of exemptive authority.”

SEC Commissioner Kara M. Stein took a more skeptical view, and urged the SEC to provide “more thought and attention” to Regulation Crowdfunding. Commissioner Stein focused on the role of funding portals, and asked whether registered portals were “appropriately considering the companies and offers hosted on their platforms.” She also questioned whether the SEC should institute uniform standards for funding portals when vetting companies in order to protect investors and facilitate repeat investments.

Lofchie Comment: Commissioner Stein quite rightly raises questions about funding portals. Under the SEC’s crowdfunding rules, funding portals are subject to significant restrictions that effectively prevent them from making any money, and also subject them to significant responsibilities in order to prevent others from losing money. Given those limitations and responsibilities, the most likely sorts to take on the funding portal role might be saints and criminals. Given the way that the world tends to operate, it is not shocking that Commissioner Stein should discover more criminals than saints. If Congress and the SEC genuinely intend for crowdfunding to work, or for funding portals to play a true gatekeeping role, then they must afford those portals some means of making money.

Republican Staff Rips into “SIFI” Designation Process

Republican staff members of the House of Representatives Financial Services Committee issued a Report titled: The Arbitrary and Inconsistent FSOC Nonbank Designation Process. The Report sharply criticized the designation process by the Financial Stability Oversight Council (“FSOC”) for Systemically Important Financial Institutions (“SIFIs”), which are subject to enhanced regulatory standards.

Republican staff members analyzed nonpublic internal FSOC documents and concluded that FSOC does not adhere to its own rules and guidance in the following ways:

  • FSOC considers “non-systemic risks” when determining whether to make a “systemically important” designation.
  • FSOC “simply assumes” that financial distress at a company will cause the impairment of financial market functioning, and damage to the broader economy, without actually making such a determination, as required by FSOC’s own rules.
  • FSOC fails to follow its own requirement that the evaluation of the systemic risk posed by individual firms must be done “in the context of a period of overall stress in the financial services industry and in a weak macroeconomic environment.”
  • FSOC shows a particular lack of consistency when considering whether to factor the use of collateral in certain financial transactions into designation decisions.

Republican staff concluded that FSOC’s analysis of companies has been “inconsistent and arbitrary.”

Lofchie Comment: The legislation granting FSOC the authority to designate firms as SIFIs is open-ended and ambiguous. The legislation effectively allows the government to decide arbitrarily which companies it elects to designate as SIFIs. (Seee.g.ACLI Files Amicus Brief in MetLife v. FSOC.) The House Report found that the FSOC decision-making process was more open-ended than the provisions governing it. Patrick Pinschmidt, who was the Deputy Assistant Secretary for FSOC, makes the point more sharply in his testimony in the Appendix attached to the Report. According to Mr. Pinschmidt, “there are no bright-line thresholds in terms of what’s bad or what’s good. . . . [I]t’s a qualitative assessment based on significant qualitative analysis. . . . And it’s up to each voting member of the Council to decide . . . what constitutes a significant threshold. . . .”

There is no reason to believe that those who are in or out of government are especially good at making company-specific decisions based on qualitative factors. Picking winners and losers in the market is nearly impossible to do consistently. That is just one reason why the government should not make “qualitative” choices about which companies should be regulated.

Inevitably, the House Republicans’ report on FSOC will be criticized by Democrats as partisan. That said, Democrats should be pleased if the outcome is that the FSOC is stripped of its designation authority, since they should not want Republicans to hold this arbitrary authority and possibly use it against those who may support the Democrats. None of us should want the government to hold this arbitrary authority. Instead, let’s have clear and objective rules.

Financial Services Committee Chair Prepares “Views and Estimates” Document for Markup

Financial Services Committee Chair Jeb Hensarling circulated to Members of the Committee on Financial Services a “Views and Estimates” document for markup. Once adopted by the full committee, the document will be transmitted to the Budget Committee “to be set forth in the concurrent resolution on the budget for fiscal year 2018.”

The document is required by section 301(d) of the Congressional Budget Act which requires “each standing committee to submit to the Committee on the Budget, not later than six weeks after the President submits his budget or upon the request of the Budget Committee: (i) its views and estimates with respect to all matters to be set forth in the concurrent resolution on the budget for the ensuing fiscal year that are within its jurisdiction or function; and (ii) an estimate of the total amounts of new budget authority and budget outlays to be provided or authorized in all bills and resolutions within its jurisdiction that it intends to be effective during that fiscal year.”

The document includes the following recommendations:

  • “replace the failed aspects of the Dodd-Frank Act with free-market alternatives”;
  • “place the non-monetary policy activities of the independent agencies within the Committee’s jurisdiction on the appropriations process”;
  • “replac[e] the Orderly Liquidation Authority with established bankruptcy procedures, wherein shareholder and creditor claims are resolved pursuant to the rule of law rather than the arbitrary discretion of regulator”;
  • eliminate the Office of Financial Research, as proposed by the Financial CHOICE Act;
  • “enhance accountability and lead to greater transparency” at the Consumer Financial Protection Bureau (“CFPB”) by reforming the CFPB’s “operations and unconstitutional structure, including by subjecting the CFPB to Congressional appropriations process, and by reforming the CFPB’s statutory mandate to ensure that it takes into account, and seeks to promote, robust market competition”;
  • “modernize the SEC’s operations and structure to eliminate inefficiencies”; and
  • “promote greater accountability at the Federal Reserve by advancing legislation to fund the non-monetary activities of the Federal Reserve’s Board of 33 Governors and 12 regional banks through the Congressional appropriations process.”

Lofchie Comment: If there is an overriding theme in the initiatives contained in the Visions and Estimates document, it is that Congress chooses to assert its authority over the so-called “regulatory state,” or the unofficial fourth branch of the government. Most significantly, Congress is exercising that authority by asserting its funding power over the various regulatory agencies – particularly, the CFPB. Undoubtedly, many of these measures will be seen as reasons for Democrats and Republicans to fight, but that should not be the case with the exercise of the funding powers. The issue raised by these measures is not whether elected Democrats or Republicans are in the right concerning any particular policy decision, but whether regulatory agencies should be able to operate free of the political control of whichever party is in power.

The Visions and Estimates document provides an example of this in a section that examines the funding of the CFPB. Assuming that current CFPB Director Richard Cordray serves out his term, Mr. Cordray will remain in power until some point in 2018; he will keep his position for a substantial part of President Trump’s four-year term. President Trump then will be able to appoint a new CFPB director who could undo much of the previous director’s work and will serve well into the term of the next elected President, who easily could be a Democrat. In short, we could have a situation in which the unelected head of the CFPB is not financially accountable to Congress and acts in opposition to whoever happens to be President at a given time, whether Republican or Democrat. This is no way to structure a regulatory agency. Both Democrats and Republicans ought to prefer the CFPB to be funded by Congress and held accountable by elected political officials.

SEC Commissioner Stein Offers a Vision for the Future

SEC Commissioner Kara M. Stein cautioned regulators to “look forward” not “backward” in order to take advantage of the “amazing opportunities” created by markets in a “continual state of change.” In a speech before the 2017 “SEC Speaks” Conference, Commissioner Stein described a vision based on the premise that: “the markets exist to connect the capital of people who have saved with people who will put that capital to good use building companies and creating jobs.” She stated that: “Our policies should reflect that purpose—they should facilitate economic activity in a way that is fair and efficient and that benefits Americans who are saving and investing.”

She urged regulators to consider the impact of several market changes, including increased growth and diversity in exchange-traded products (“ETPs”), electronic trading and capital raising. She asserted that the “changes in the markets – the rise of institutional investors, the move to private markets, and the evolution of electronic trading – are all closely intertwined.”

On issues of disclosure, Commissioner Stein recognized that the Consolidated Audit Trail and similar regulatory developments will enhance disclosure requirements, and emphasized that “much more needs to be done.” Commissioner Stein stated that regulators themselves must change:

“The landscape in which we operate is quickly and fundamentally shifting. We too need to change. We cannot address the new world by simply turning the clock backward. Instead, we must look to the future.”


Lofchie Comment: Commissioner Stein’s vision of the future is about more regulation. When she asks why companies stay private for longer periods of time, she does not consider the possible answer that the costs of regulation are not worth the benefits of going public. Her conclusion is never whether regulation is the answer, only which regulation is the answer, as in: “Should we apply enhanced disclosure laws to these private companies? Or perhaps they require a unique set of rules.”

It is possible that Commissioner Stein is right, and that more disclosure could be needed. However, better reasoning demands broader questions. Perhaps one might ask: “Should we reduce the burden on public companies so that growing companies are more willing to register with the SEC?” Both questions (i.e., whether we should have more regulation or less) are worth asking. Ideally, all of the SEC Commissioners would raise and address both types of questions. Certainly, Commissioner Stein should consider why, for the past eight years, issuers have trended toward being willing to forego the benefits of the public markets in order to avoid the costs.

Sargen on China – U.S. Tensions…Diminish for Now


  • Notwithstanding adverse political news at home, the Trump rally has continued amid favorable economic news and investor optimism about pending corporate and personal income tax cuts.  Diminished tensions between the Trump Administration and China have also lessened the risk of a trade war.
  • The key event was President Trump’s reaffirmation of the “One China” policy to President Xi in a telephone exchange earlier this month.  At the same time, Defense Secretary Mattis talked about the need for a diplomatic rather than military solution to the dispute in the South China Sea, which the Foreign Ministry in China welcomed.
  • With Steve Mnuchin assuming the helm as Treasury Secretary, market participants are awaiting the stance the Treasury will take on whether to declare China a “currency manipulator.”  Press reports suggest the Trump Administration may change tactics, so that China is not singled out.
  • The bottom line: The risk of an escalation in tensions between the U.S. and China has lessened, and it appears moderates in the Trump Administration are calling the shots.   Nonetheless, circumstances could change if the dispute in the South China Sea heats up or if China’s trade surplus with the U.S. were to increase.

President Trump Moderates His Stance on China

At a time when the Trump Administration has been engulfed with a series of adverse political developments, market participants appear oblivious to them, and the so-called Trump rally lives on.  The principal reasons are that news on the economic front has been favorable, consumer and business confidence readings remain high, and investors are focused on the prospect for significant cuts in both corporate and personal tax rates.

In addition, a potential negative factor –namely, the prospect for a trade war between the U.S. and China – has also diminished recently.  The key development was a sudden reversal in President Trump’s stance toward China.  Throughout the presidential campaign, Mr. Trump took a hard line on China, claiming that its trade policies were unfair, and on several occasions he called for imposing tariffs of 35% on Chinese imports into the U.S.  Immediately after assuming office, President Trump upped the ante by congratulating the leader of Taiwan and by indicating he was open to reviewing the One China policy that China’s leaders regard as non-negotiable.

During the past month, however, the Trump Administration has softened its stance considerably.  In a telephone conversation with China’s leader, Xi Jinping, the President retreated from his earlier statement, and he indicated the White House had agreed to honor the One China policy “at the request of President Xi.”

The timing of the call was significant, coming just before President Trump met with Japanese Prime Minister Shinzo Abe to discuss the commitment of the U.S. to East Asia. It also coincided with a trip to Japan and South Korea by Defense Secretary Mattis, during which he talked of the need for a diplomatic rather than military solution to the dispute over islands in the South China Sea. The Foreign Ministry in Beijing welcomed the remarks and the Chinese press called them a “mind-soothing pill” that “dispersed the clouds of war.”1

Looking behind the scenes, these developments suggest that moderates in the Administration such as Secretary of State Rex Tillerson, Defense Secretary James Mattis and National Economic Council Director Gary Cohn are calling shots on China policy for the time being.  This is reassuring to those who worried that Peter Navarro, Wilbur Ross, and Robert Lightziger, who have a more protectionist bent, could be in charge of trade policy.

Is China a Currency Manipulator?

With Steven Mnuchin now confirmed as Treasury Secretary, market participants will now be watching to see whether the Treasury declares China to be a “currency manipulator,” as Mr. Trump suggested during the presidential campaign.  Since 2015, the criteria that the Treasury has used for making such a designation has been three-fold: (i) the country has a large current account surplus, defined to be in excess of 3% of GDP; (ii) it has a large bilateral trade surplus with the U.S.; and (iii) it intervenes in the currency markets to weaken its currency versus the U.S. dollar.

Based on these criteria, China meets only one condition – namely, it has a large bilateral surplus with the U.S.  Its overall current account surplus, by comparison, has fallen steadily over the past decade, and is currently less than 3% of GDP.  And while the Chinese authorities intervene regularly in the foreign exchange markets, since 2014 they have been primarily sellers of U.S. dollars.  The reason: China has experienced massive capital flight that far exceeds its currency account surplus, and the authorities have been trying to limit the depreciation of the RMB versus the dollar.

Weighing these considerations, the Treasury in the past has refrained from declaring China to be a currency manipulator.  If it were to do so now, the rationale would be political rather than economic.  Even then, it is unlikely the Trump Administration would want to escalate the issue at this time when it already has moderated its stance.

A recent Wall Street Journal article (February 14, 2017) stated that the White House is exploring a new tactic to discourage China from undervaluing its currency.  Under the plan the Commerce Secretary would designate the practice of currency manipulation as an unfair subsidy, without singling out China, and U.S. companies could then bring complaints to the Commerce Department.  While this tactic is in keeping with the stance adopted by previous administrations, Chinese officials reportedly are bracing for an unprecedented number of trade disputes, and they are considering possible retaliatory actions.

Avoiding a Full Scale Trade War

Both the United States and China for the time being are seeking to avoid a full scale trade war that would produce a “lose-lose” situation.  Investors, nonetheless, must consider the possibility of such an outcome in the future, especially if China’s bilateral trade surplus with the U.S. were to widen, while the RMB would weaken further against the dollar.

The latter outcome remains a distinct possibility for two reasons.  First, U.S. import demand is likely to surge if the U.S. economy continues to gain traction, and imports from China would in turn be boosted. Second, a stronger economy is likely to bring the Fed into play, and a widening in interest differentials between the U.S. and China would place added pressure on the RMB. In these circumstances, the Trump Administration could very well come down on the side of those who contend China is manipulating its currency, even if the Chinese authorities intervene to limit the depreciation of the RMB.

In these circumstances, markets are likely to focus on whether any sanctions imposed by the U.S. are targeted to specific items or are broadly based and severe. In the former case, markets would likely take the news in stride, as there are numerous instances in which the U.S. has imposed sanctions on select items.  However, if the Trump Administration were to up the ante by imposing broad-based sanctions – including high tariffs across a wide range of goods – markets would likely sell off, as investors would anticipate retaliation by the Chinese authorities and other countries that are affected.

Our assessment is the risk of a full scale trade war has lessened for the time being.  However, political developments such as a widening in the dispute over islands in the South China Sea or adverse developments in the U.S. could result in an escalation of trade tensions at some point.  In this respect, the risk of a trade war cannot be ruled out entirely.

1See Goldman Sachs report “Top of Mind,” February 6, 2007.

NY Financial Services Department Adopts Final Revisions to Cybersecurity Requirements

The New York Department of Financial Services (“DFS”) adopted final revisions to its new cybersecurity regulations, which apply to a wide range of insurance, banking and financial services companies (“Covered Entities”) under its supervision (see previous coverage of the proposed revisions). The regulations will take effect on March 1, 2017 and, starting in 2018, will require a Covered Entity to prepare and submit a Certification of Compliance annually by February 15 to the DFS concerning the firm’s cybersecurity compliance program.

Required elements of the program include (i) the means to prevent and detect cyber events, (ii) the development of a cybersecurity policy, (iii) the appointment of a “qualified” chief information security officer, (iv) testing programs, (v) audit trails and (vi) access controls.

New York Governor Andrew M. Cuomo praised the new regulations:

“These strong, first-in-the-nation protections will help ensure [the financial services] industry has the necessary safeguards in place in order to protect themselves and the New Yorkers they serve from the serious economic harm caused by these devastating cyber-crimes.”


Lofchie Comment: New York State has been very aggressive in regulating and sanctioning firms engaged in financial activities. In their original form, the rules proposed by New York State to regulate “money laundering” set impossible-to-meet compliance standards. (Ultimately, the rules adopted by New York State were less draconian than those that were proposed originally, but that is saying very little.) The adopted Cybersecurity regulations are open-ended, complex and burdensome and will result in creating many new ways for the government to collect fines when something goes wrong. The fact that New York State rushed to declare itself “first in the nation” to adopt such a detailed set of rules suggests that its local government is too eager to place onerous requirements on the financial sector and, as a consequence, expand opportunities to collect fines.

That said, firms must abide by the new compliance obligations and do their best not to give New York State an opportunity to collect.

An Interview with William A. Barnett

CFS Director William A. Barnett is interviewed by Apostolos Serletis.  The conversation covers Bill’s life as a rocket scientist, work at the Federal Reserve Board, pioneer of monetary aggregation and complex dynamics, founding journals and societies, work at CFS, and more.

The interview is similar in construct to discussions with eminent economists in Bill’s book co-edited with Nobel Laureate Paul Samuelson – “Inside the Economist’s Mind.”

To view the full interview:

I hope that you find the exchange about Bill and his remarkable career informative and enjoyable.

FINRA Sets Effective Date for Mark-up/Mark-down Disclosure Requirements

FINRA notified member firms that the SEC approved FINRA amendments to Rule 2232 in order to require the disclosure of markups on certain transactions in corporate debt or agency securities with retail customers (i.e., customers that are not institutional accounts as defined in FINRA Rule 4512(c)). For covered transactions, the amendments require dealers to disclose mark-ups or mark-downs from the prevailing market price for the relevant security on the customer confirmation that the dealer sells or buys the security to or from a retail customer, and then buys or sells the same security as principal in an equal or greater amount on the same day from another party.

FINRA noted that the final amendments will become effective on May 14, 2018, which is the same date as the effective date for the MSRB’s parallel confirmation disclosure requirements.

Lofchie Comment: Firms should allow sufficient time for putting the technology and processes in place to comply with the new rules, which could be fairly complicated to implement given the need to “match” prices on particular purchases and sales that often will not bear any particular relationship to one another. Markups will be required to be disclosed on certain transactions for which there is deemed to be an offset, but not on similar trades that cannot be matched to a trade on the other side of the market. Even after the trade matching and markup calculation system is implemented, ongoing checks will be required in order to ensure that it is functioning.