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What We’re Reading in Financial Regulatory Reform, January 16

Friday, January 16, 2015

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This Martin Luther King, Jr. weekend, we hope you enjoy our latest selection of readings from the financial regulatory world. 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’s Financial Regulatory Reform Initiative 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.

Compiled by Aaron Klein, Peter Ryan and Justin Schardin

“Let’s Leave Wall Street’s Risky Practices in the Past,” an op-ed in The Washington Post
By Jacob Lew, Secretary, U.S. Department of the Treasury

“Opponents who are fighting to repeal these reforms, or impede implementation, make no secret that they are gearing up for a multifront assault to weaken effective oversight of Wall Street and protections for Main Street. Their focus — which includes weakening the newly created and already effective consumer watchdog agency, eroding transparency in the derivatives markets and underfunding the regulators in charge of enforcement and oversight — amounts to an agenda that would take us back to the dangerous conditions that existed before the financial crisis.” Read the op-ed here.

This week, MetLife, Inc. announced its intention to take legal action challenging the Financial Stability Oversight Council’s (FSOC) decision to designate it as a systemically important financial institution (SIFI). FSOC’s reasons for designating MetLife and MetLife’s legal complaint are included below.

Basis for the Financial Stability Oversight Council’s Final Determination Regarding MetLife Inc.

“Because MetLife, Inc. (MetLife) is a significant participant in the U.S. economy and in financial markets, is interconnected to other financial firms through its insurance products and capital markets activities, and for the other reasons described below, material financial distress at MetLife could lead to an impairment of financial intermediation or of financial market functioning that would be sufficiently severe to inflict significant damage on the broader economy. Based on the Council’s evaluation of all the facts of record in light of the factors that the Council is statutorily required to consider, the Council has made a final determination that material financial distress at MetLife could pose a threat to U.S. financial stability and that MetLife will be supervised by the Board of Governors and be subject to enhanced prudential standards.” Read the document here.

MetLife, Inc. v. Financial Stability Oversight Council. Complaint filed in the U.S. District Court for the District of Columbia

“FSOC made numerous critical errors that fatally undermined the reasoning in its Final Designation of MetLife. First, FSOC failed to understand, or give meaningful weight to, the comprehensive state insurance regulatory regime that supervises every aspect of MetLife’s U.S. insurance business. … Second, FSOC fixated on MetLife’s size and so-called interconnections with other financial companies—factors that, considered alone, would inevitably lead to the designation of virtually any large financial company—and ignored other statutorily mandated considerations that weighed sharply against designation. Third, FSOC consistently relied on vague standards and assertions, unsubstantiated speculation and unreasonable assumptions that are inconsistent with historical experience (including prevailing conditions in the 2008 financial crisis), basic economic teachings and accepted principles of risk analysis. … Fourth, FSOC repeatedly denied MetLife access to data and materials consulted and relied on by the Council in making its designation determination, thereby depriving the Company of a meaningful opportunity to rebut FSOC’s assumptions or otherwise respond to its analysis, in violation of MetLife’s due process rights.” Read the complaint here.

Notice Seeking Comment on Asset Management Products and Activities

“The Council has been engaged in work over the past year to analyze risks associated with the asset management industry and whether any such risks could affect U.S. financial stability. … The Council is now seeking public comment in order to understand whether and how certain asset management products and activities could pose potential risks to U.S. financial stability. Specifically, this Notice requests information about whether risks associated with liquidity and redemptions, leverage, operational functions and resolution in the asset management industry could affect U.S. financial stability.” Read the notice here.

“Asset Management, Financial Stability and Economic Growth”
By the Initiative on Business and Public Policy, The Brookings Institution

“Asset managers play a critical role in our economy, channeling funds from investors to businesses to support economic growth and employment. Their allocation decisions help determine the efficiency with which our economy operates and those decisions also affect financial stability. There is an active policy debate on how to regulate asset managers to maximize economic growth without endangering financial stability. On January 9, the Initiative on Business and Public Policy at Brookings hosted an event addressing these issues, with experts from a variety of backgrounds sharing their perspectives.” Watch video from the event here.

“The Board Should Enhance Its Supervisory Processes as a Result of Lessons Learned from the Federal Reserve’s Supervision of JPMorgan Chase & Company’s Chief Investment Office”
By the Office of Inspector General, Board of Governors of the Federal Reserve System and the Consumer Financial Protection Bureau

“In May 2012, media outlets reported that JPMorgan Chase & Company’s (JPMC) Chief Investment Office (CIO) incurred approximately $2 billion in losses due to a complex trading strategy involving credit derivatives. Losses continued over the following months and surpassed $6 billion by the end of 2012. This matter highlighted corporate governance, risk management and internal control weaknesses at JPMC. … In July 2012, we initiated this evaluation (1) to assess the effectiveness of the Board of Governors of the Federal Reserve System’s (Board) and the Federal Reserve Bank of New York’s (FRB New York) consolidated and other supervisory activities regarding JPMC’s CIO and (2) to identify lessons learned for enhancing future supervisory activities… Our report contains 10 recommendations that encourage the [Board] to enhance its supervisory processes and approach to consolidated supervision for large, complex banking organizations as a result of lessons learned from the Federal Reserve’s supervision of JPMC’s CIO.” Read the report here.

Letter to Regulators Regarding Credit Card Security
By Sen. Mark Warner (D-VA)

“I have concerns … that as merchants spend billions of dollars this year to upgrade their infrastructure to accept chip-and-PIN enabled cards, there is insufficient emphasis being placed by federal banking regulators on ensuring a meaningful improvement in consumer safety. … I am interested in learning more about what your organizations are doing to ensure the U.S. financial system addresses its security issues and begins to lead the way in this area.” Read the letter here.

Payments Policy in the 21st Century: The Promise of Innovation and the Challenge of Regulation featuring Keynote Address by Superintendent Benjamin Lawsky

On December 18, 2014, the Bipartisan Policy Center hosted a discussion analyzing how new technologies will impact consumers, businesses, financial institutions as well as state and federal oversight. The event also explored current policy and regulations, and whether additional reforms are needed to protect consumers, promote a fair marketplace and encourage further innovation and economic growth. Benjamin Lawsky, the Superintendent of the New York Department of Financial Services, gave a keynote on the regulation of Bitcoin and other new payment technologies. Watch video from the event (including Superintendent Lawsky’s remarks) here.

Request for Comment: Prepaid Accounts Under the Electronic Fund Transfer Act (Regulation E) and the Truth in Lending Act (Regulation Z)
By the Consumer Financial Protection Bureau (CFPB)

“The proposal would create comprehensive consumer protections for prepaid financial products. …  The proposal would generally cover those prepaid accounts that are cards, codes or other devices capable of being loaded with funds and usable at unaffiliated merchants or for person-to-person transfers and are not gift cards (or certain other related types of cards).” Read the proposed rule here.

Pocket Policy: Do New Payments Technologies Need New Rules?
By Aaron Klein

“There is a growing battle between my left pocket, where I keep my phone, and my right pocket, where I keep my wallet. New innovations like Apple Pay and applications like Uber allow me to make payments with only my phone, leaving my wallet sitting in my pocket. Americans are reacting to these new options and changing their purchasing behavior, while policymakers and the financial industry are trying to ensure the payment system evolves along with changing consumer and business habits. That is why the Bipartisan Policy Center is planning a series of public forums, private discussions and other events over the coming months to examine how regulators will need to adapt to the opportunities created and challenges posed by these new technologies.” Read the blog post here.

“Regulating Risk: Implementation Risk in New Regulation. Phase-In Compliance of Volcker’s Treatment of CLOs Will Help Avoid Fire Sales”
By Hamilton Place Strategies

“While Volcker Rule is a much broader regulation (well beyond [collateralized loan obligations] CLOs), the minor provision in H.R. 37 keeps the Volcker Rule’s ban on proprietary trading and covered funds completely intact. It simply affords a phased-in compliance aimed at existing CLOs created before the Volcker Rule was finalized. For CLOs issued after Jan. 31, 2014, this provision changes nothing. While the change is small by financial regulatory standards, H.R. 37 will help ensure the Volcker Rule does not force banks of all sizes into fire sales, potentially leading to billions of dollar of losses that would threaten credit access for American businesses.” Read the report here.

“Shedding Light on Shadow Banking.” IMF Working Paper
By Artak Harutyunyan, Alexander Massara, Giovanni Ugazio, Goran Amidzic and Richard Walton, International Monetary Fund (IMF)

“In this paper, we develop an alternative approach to estimate the size of the shadow banking system. … We base our alternative approach on the expansion of the noncore liabilities concept developed in recent literature to encompass all noncore liabilities of both bank and nonbank financial institutions. As opposed to existing measures of shadow banking, our newly developed measures capture nontraditional funding raised by traditional banks. We apply the new approach to 26 jurisdictions and analyze the results over a twelve-year span. We find that noncore liabilities are procyclical and display more volatility than core liabilities for most jurisdictions in the sample.” Read the article here.

“Worker Flows in Banking Regulation,” Liberty Street Economics Blog, Federal Reserve Bank of New York
By David Lucca, Federal Reserve Bank of New York, Amit Seru, University of Chicago’s Booth School of Business, and Francesco Trebbi, University of British Columbia

“In the aftermath of the 2008 financial crisis, job transitions of personnel in banking supervision and regulation between the public and private sectors—often labeled the revolving door—have come under intense scrutiny. … Our data show clear evidence of higher worker inflows to the regulatory sector during bad economic conditions. When we study worker flows as a function of an enforcement proxy, we find evidence to be inconsistent with the often-cited ‘quid-pro-quo’ hypothesis. We instead posit an alternative ‘regulatory schooling’ hypothesis that may better explain the empirical evidence.” Read the blog post here and the full paper here.

What’s in Store for the Latest Federal Reserve Board Nominee?
By Justin Schardin

“[T]he Obama administration still needs to fill two more positions on the Federal Reserve Board: one as a governor and one as the vice chairman for supervision. We do not yet know whether the president plans to nominate [Allan] Landon for the seat vacated by Sarah Bloom Raskin 299 days ago in March, or the one vacated by Jeremy Stein 223 days ago in May. The choice matters since the term to which Raskin was confirmed expires on February 1, 2016, while Stein’s expires two years later. The position of vice chair for supervision has been vacant for 1630 days since it established by the Dodd-Frank Act in July 2010, according to the Nominations Tracker.” Read the blog post here.