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What We're Reading in Financial Regulatory Reform: April 17

We hope that you enjoy the following selection of readings this Passover and Easter weekend. As always, the views expressed in these articles do not necessarily represent the views of the initiative, its co-chairs, task force members or the Bipartisan Policy Center (BPC).

BPC’s Financial Regulatory Reform Initiative (FRRI) highlights news articles, papers and other important work which illuminate current and new thinking within financial regulation. We circulate these articles to provide a full view of cutting edge ideas, reactions and positions. For more information on FRRI, including recent research and upcoming events, click here.

Compiled by Aaron Klein, Peter Ryan, Justin Schardin

Modernizing Our Regulatory Structure
By Richard H. Neiman and Mark Olson, Co-Chairs of the Financial Regulatory Reform Initiative’s Regulatory Architecture Task Force, Bipartisan Policy Center

“Streamlining America’s financial regulatory architecture was a major missed opportunity in the Dodd-Frank Act. Our existing structure is a patchwork of reactions to past financial crises that date back more than 150 years. Modernizing this patchwork system would improve regulation, enhance financial stability and increase economic growth. Today, we propose a road map for how to achieve these goals.” Read the op-ed here and BPC’s report Dodd-Frank’s Missed Opportunity: A Road Map for a More Effective Regulatory Architecture here.

Speech at the Federal Reserve Bank of Atlanta’s 2014 Financial Markets Conference
By Janet Yellen, Chair, Board of Governors of the Federal Reserve System

While the [liquidity coverage ratio] LCR and [net stable funding ratio] NSFR are important steps forward, they do not fully address the financial stability concerns associated with short-term wholesale funding. These standards tend to focus on the liquidity positions of firms taken in isolation, rather than on the financial system as a whole. They only apply to internationally active banks, and not directly to shadow banks, despite the fact that liquidity shocks within the shadow banking system played a major role in the crisis. … Federal Reserve staff are actively considering additional measures that could address these and other residual risks in the short-term wholesale funding markets. Some of these measures–such as requiring firms to hold larger amounts of capital, stable funding, or highly liquid assets based on use of short-term wholesale funding–would likely apply only to the largest, most complex banking organizations. Other measures–such as minimum margin requirements for repurchase agreements and other securities financing transactions–could, at least in principle, apply on a marketwide basis. In designing such measures, we are carefully thinking through questions about the tradeoffs associated with tighter liquidity regulation that will be discussed at this conference. Read the speech here.

Global Financial Stability Report
By the International Monetary Fund

“A potential weakness of the [Dodd-Frank Act] is that the regulatory structure remains fragmented. Differences in those agencies’ perspectives can make it hard to reach agreement on key priorities and slow decision making. They can also impede implementation when agreement is reached, particularly if agreement was only by majority vote and not by consensus. Given that the ultimate power to take regulatory action rests with the agencies, FSOC recommendations may not develop traction in such cases, causing delay in implementation. An example of such tension is the protracted debate over reform of money market mutual funds. The relevant agencies followed the FSOC’s recommendations on the matter only partially and with considerable delay. These difficulties suggest that the process of issuing recommendations to member agencies could be too cumbersome if an important and time-sensitive systemic threat is identified. … A way to partially overcome the structural implementation problems is for the FSOC to more extensively designate systemically important non-bank financial institutions, thereby moving primary supervisory oversight of them to the Federal Reserve.” Read the full report here.

Final Rule on Supplementary Leverage Ratio for the Largest U.S. Bank Holding Companies
By the Federal Reserve Board, Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC)

“The [agencies have] adopted a final rule to strengthen the leverage ratio standards for the largest, most interconnected U.S. banking organizations. The final rule applies to U.S. top-tier bank holding companies with more than $700 billion in consolidated total assets or more than $10 trillion in assets under custody (covered BHCs) and their insured depository institution (IDI) subsidiaries. Covered BHCs must maintain a leverage buffer greater than 2 percentage points above the minimum supplementary leverage ratio requirement of 3 percent, for a total of more than 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments. … The final rule, which has an effective date of January 1, 2018, currently applies to eight large U.S. banking organizations that meet the size thresholds and their IDI subsidiaries.” Read the press release here and the final rule here.

Speech at the American Bar Association on the Notice-and-Comment Rulemaking Process
By Richard Cordray, Director, Consumer Financial Protection Bureau (CFPB)

“[T]he rules that we are writing typically will cover a wide range of institutions, from trillion-dollar megabanks to small community banks or credit unions that may have just a few employees and assets counted in the millions of dollars rather than the trillions. Like the average consumer, these businesses have much to contribute to the rulemaking process, but they, too, may find it difficult to provide input. So we are working to reimagine the notice-and-comment process for our rulemakings. This is not an easy job, since consumers and small businesses are inundated with information, and capturing their attention is no easy task. Moreover, government agencies are not typically known for communicating with consumers or small business in a clear fashion – but we want to change that.” Read the full speech here.

Letter to G20 Finance Ministers and Central Bank Governors: “Financial Reform – Update on Progress”
By Mark Carney, Governor, Bank of England and Chairman, Financial Stability Board

“I reported in February on the priorities, agreed by G20 Leaders in St. Petersburg, for substantially completing the core of the G20’s programme of fundamental reform of the global financial system during the Australian Presidency. We are on-track to deliver for the Brisbane Summit, but difficult decisions remain to be taken in three particular areas where the support of Ministers and Governors is essential: ending too-big-to-fail; transforming shadow banking to transparent and resilient market based financing; and making derivatives markets safer. This letter summarises the progress to complete the programme of reform for the Brisbane summit, begins to look ahead to plans for implementation beyond Brisbane, and summarises the initial findings of the FSB review of representation.” Read the letter here.

Comments on the Financial Stability Board’s Consultative Document on Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions
By Barbara Novick, Vice Chairman, BlackRock Inc.

“Asset managers are not a source of systemic risk. Given the agent business model, asset managers are neither the owner of the assets under their management nor the counterparty to trades or derivative transactions undertaken on behalf of clients. Clients regularly change managers with no impact on the capital markets; typically, the assets will continue to reside at the same custodian regardless of whom the owner of the assets appoints as manager. In the unlikely event a manager went out of business, clients would move the asset management to one of many competitors. Asset managers do not control entity-level asset allocation decisions, so any concerns about ‘herding’ would need to be addressed with ‘asset owners’ rather than with their agents, the asset managers.” Read the full comment letter here.

Joint Agency Letter to Rep. Jeb Hensarling, Chairman of the Committee on Financial Services, U.S. House of Representatives, regarding treatment of Collateralized Loan Obligations (CLOs)
By Daniel K. Tarullo, Governor, Board of Governors of the Federal Reserve System; Martin J. Gruenberg, Chairman, FDIC; Thomas J. Curry, Comptroller of the Currency, OCC; Mary Jo White, Chair, Securities and Exchange Commission (SEC); and Mark P. Wetjen, Chairman, Commodity Futures Trading Commission (CFTC)

“CLOs refer to securitization vehicles that are backed predominately by commercial loans. … Soon after issuance of the implementing rules the Agencies began receiving inquires about whether legacy CLOs would be subject to the prohibition on ‘covered funds’ and, therefore, subject to a requirement for divesture not later than the end of the statutorily permissible conformance period. We have taken the concerns express in these inquiries very seriously. … To address the concerns regarding CLOs, the Federal Reserve Board has issued a statement that it intends to grant two additional one-year extension of the conformance period under section 619 that would allow banking entities additional time to conform to the statute ownership interests in and sponsorship of CLOs in place as of December 31, 2013. … The undersigned support the statement issued by the Federal Reserve Board.” Read the letter here.

Tapping the Breaks: Are Less Active Markets Safer and Better for the Economy?
By Joseph E. Stiglitz, Professor, Columbia University

“The last quarter century has been marked by a high level of financial innovation. But the theory of innovation has emphasized that there can be marked discrepancies between the social and private returns to innovation, and whenever that is the case, innovations may not be welfare enhancing. There can be private returns associated with ‘stealing’ rents from others, or from extending and strengthening market power, or from regulatory arbitrage, circumventing (within the law) regulations intended to reduce externalities and increase the stability of the economy. The analysis runs parallel to that of earlier sections that argued that some of the innovations in financial markets, those that have enabled flash trading, may not have been welfare enhancing.” Read the full article here.

The Lewis Effect
By Felix Salmon, Slate Magazine

“The problem with Flash Boys, at heart, is that Lewis is too wedded to his narrative of a rigged stock market. The word ‘“fraud’ appears in three different places in the book. … But what we’re seeing, in the world of HFT, is not fraud, nor is it insider trading. Rather, HFT is a ridiculously and unnecessarily complicated mechanism for divvying up intermediation revenues between banks, exchanges, high-tech telecommunications outfits, and various algo-driven shops.” Read the full article here.

Do Bond Spreads Show Evidence of Too Big to Fail Effects? Evidence from 2009-2013 Among U.S. Bank Holding Companies
John Lester and Aditi Kumar, Oliver Wyman, on behalf of The Clearinghouse Association

“We do not find strong evidence that differences in bond spreads between [global systemically important bank] G-SIBs and other [bank holding companies] BHCs can be consistently attributed to [too-big-to-fail] TBTF perceptions over the 2009-2013 period. We use bond trade data to trace the evolving differences between G-SIB bond spreads and other BHC bond spreads. … [W]e estimate a large and statistically significant bond spread advantage for G-SIBs of 137 bps in 2009 which declines each year thereafter, to 57 bps by 2011. Extending the analysis to 2013, we find that the measured G-SIB funding advantage continues to decline and becomes statistically insignificant (i.e. it cannot be confidently distinguished from zero). Further, we find that even in the years that we do observe a G-SIB bond spread advantage, this advantage cannot necessarily be attributed to TBTF related factors.” Read the full report here.

‘Principled Solutions’ Needed to End Destructive Overdraft Fees
By Wade Henderson, President and CEO of The Leadership Conference on Civil and Human Rights, and Mike Calhoun, President of the Center for Responsible Lending

“Smart banking solutions can be a step toward protecting consumers against the malicious effects of overdraft fees. Greater movement toward up-front charges and the elimination of back-end fees, like overdrafts, also enables consumers to predict the cost of a checking account and shop accordingly, thus introducing greater competition into the market.” Read the article here.

How Important are Hedge Funds in a Crisis?
By Reint Gropp, Chair of Sustainable Banking and Finance at Goethe University, Frankfurt and Visiting Scholar, Federal Reserve Bank of San Francisco

“Even though there were prominent cases of insurance companies, such as AIG, that were adversely affected by the crisis, the model suggests that insurance companies are not systemically important in the sense of causing distress elsewhere. Rather, they appear as relatively safe during crises, as their returns tend to be negatively related to the returns of other financial institutions. Hedge funds, on the other hand, adversely affect all three other types of financial institutions. During crises, the spillovers become very large, making hedge funds more important transmitters of shocks than commercial banks or investment banks.” Read the full article here.

Dodd-Frank Comes for the Insurers
Ben Nelson, CEO, National Association of Insurance Commissioners

“State insurance regulation works because it’s specific to the industry’s unique risks. States are able to tailor a risk-based capital system to their own needs, with different methods for life, health and property and casualty insurance. Those requirements consider all possible sources of risk—from asset risk to underwriting risk to operational risk—when determining minimum holding requirements. The Federal Reserve, on the other hand, will likely subject insurance companies to a one-size-fits-all bank capital framework.” Read the op-ed here.

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