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What We're Reading in Financial Regulatory Reform, May 22

We hope that you enjoy the following selection of videos and readings this Memorial Day 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’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. For more information on FRRI, including recent research and upcoming events, click here.

Compiled by Aaron Klein, Peter Ryan, Justin Schardin

Interview with former U.S. Secretary of the Treasury Timothy Geithner

This week, former Secretary of the Treasury Timothy Geithner released his memoir Stress Test: Reflections on Financial Crises. Below is an interview between Secretary Geithner and Ezra Klein of Vox.

Financial Stability Oversight Council 2014 Annual Report

“While many different forms of funding are an integral part of the traditional banking model, firms should diversify their funding base and place prudent limits on the volume of credit-sensitive, short-term liabilities. On liquidity risk management, the Council recommends that supervisors and private sector risk managers closely monitor the risks inherent in short-term funding of longer-term assets. In 2013, the federal banking agencies proposed a liquidity coverage ratio (LCR) that would strengthen the liquidity position of large banking firms. The Council recommends that the agencies continue to work expeditiously to finalize the LCR and continue work on potential quantitative rules that would address longer-term liquidity needs for banking organizations.” Read the full report here.

Remarks to the Conference of State Bank Supervisors
By Thomas J. Curry, Comptroller of the Currency

“I think we need to remember that the true measure of our success as bank regulators is strong, credible supervision of individual state and federal banks and of the dual system as a whole. The dual banking system, for the most part, relies on assessments from the institutions we regulate to fund our operations. This system of funding enables us to exercise independent supervisory judgment. On the other hand, it can also leave us vulnerable to regulatory capture. Regulatory capture is a real threat to our agencies and the banking system we oversee. As regulators, we need to take great care to avoid doing anything that even creates that perception. We have seen examples of banking and deposit insurance agencies that suffered significant reputational damage, and in some cases were ultimately abolished, because the public saw them as serving private, rather than public, interests. We should never employ our chartering authority to compete for ‘market share.’” Read the full speech here.

Remarks to the Council of Institutional Investors
By Kara M. Stein, Commissioner, Securities and Exchange Commission

“Many of us continue to think about the lessons learned from the financial crisis. I am concerned that investors may not have sufficient information about some issuers’ reliance on short-term funding for their long-term obligations. Companies’ funding-liability mismatches played a key role in the crisis, and we need to make sure that we do what we can to prevent that from happening again. One way to do that is to enhance disclosures about issuers’ funding arrangements. With additional transparency, shareholders can help rein in companies that become too reliant on short-term funding. Investment company disclosures regarding securities lending activities are also something that we should explore. Shouldn’t a fund disclose both the percentage of its assets out on loan, and how it splits revenue from securities lending with its sponsor? Improving these disclosures could help investors make smarter choices.” Read the full speech here.

Letter to Treasury Secretary Lew, Federal Reserve Chair Janet Yellen, and SEC Chair Mary Jo White Regarding FSB and FSOC SIFI Designation Processes
By Representatives Jeb Hensarling, Scott Garrett, Randy Neugebauer, Shelley Moore Capito, Patrick McHenry, and John Campbell

“As you know, the [Financial Stability Board (FSB) is in the process of examining certain U.S. companies for possible designation as [globally systemically important financial institutions (G-SIFIs)]. While we agree that robust communications between U.S. regulators and their overseas counterparts is important for global financial stability, we have concerns that decisions are being made that could have significant impact on the U.S. economy and its citizens through a nontransparent process, by an international body that is not accountable to the American people.

“Both FSOC [Financial Stability Oversight Council] and FSB appear to take a ‘we-know-it-when-we-see-it’ approach to identifying firms that pose a risk to financial stability. In particular, there do not appear to be clear rules or criteria to determine when a non-banks financial institution qualifies as a ‘systemic risk’ to the U.S. or global financial systems. … Nor have the FSOC or the FSB ever adequately explained the degree of systemic risk needed to merit designation as a SIFI. Companies that are currently under review by FSOC and the FSB have stated that they have not even been able to meet with voting members to discuss their potential designation. … Further, once a designation is made, neither FOSC nor the FSB provides any direction about what steps the companies can take to have that designation revoked. … This overall lack of transparency and due process injects needles uncertainty and instability into our financial markets.” Read the full letter here.

Letter to Representative Darrell Issa Regarding OFR Asset Management Study
By Alastair Fitzpayne, Assistant Secretary for Legislative Affairs, U.S. Department of the Treasury

“Your letter also suggests that the OFR [Office of Financial Research] did not consider the input and expertise of the Securities and Exchange Commission (SEC) in drafting the study. We respectfully disagree. The record described below and reflected in the enclosed documents shows that as it was drafting its report, the OFR engaged in extensive and meaningful collaboration with Council member agencies, in particular with the SEC. This process involved the exchange of 15 drafts and eight months of discussions between the OFR and SEC staff, including over a dozen in-depth conversations on the substance of the study, and the final OFR study reflects many, but not all, of the SEC’s suggested edits.” Read the full letter here.

Letter to Treasury Secretary Lew Regarding FSOC Asset Manager Designation Process
By Senator Mark Warner

“The impetus for consideration of asset managers as non-bank SIFIs appears to be based upon a report issued by OFR last September. Yet that report has come under considerable scrutiny. Given the importance of the report’s contents, I believe it would be worthwhile for the OFR and FSOC to examine some of the comments received by the SEC when it solicited feedback from the public. More disconcerting, however, is that the path to designation already appears to be proceeding despite the fact that FSOC has not yet… engaged in substantial direct engagement with the asset management industry, which could provide a wealth of data for the OFR and FSOC to independently review. The lack of engagement and transparency around this process has created uncertainty about the basis for recent press reports that the designation process has advanced to stage 2 for some companies.” Read the full letter here.

Letter to the SEC Providing Feedback on OFR Asset Management Study
By Daniel M. Gallagher, Commissioner, Securities and Exchange Commission (SEC)

“In September 2013, OFR released its findings in the OFR Report, a document riddled with fundamentally flawed conclusions that were the inevitable result of the deeply unsound process followed by OFR in its performing its analysis… The end product was a botched analysis that grossly overstates indeed, in many cases simply invents without supporting data – the potential risks to the stability of our financial markets posed by asset management firms.”

“Exponentially compounding the mistakes of fact and poor substantive analysis contained in the OFR Report was OFR’s brazen refusal to consider the comments and input of experts from the SEC, the very agency charged by Congress with regulating asset managers. The Commission has had regulatory authority for over seventy years to oversee the asset management industry, yet the comments of SEC staff – many of which were meant to correct or clarify plainly inaccurate statements and non-sequiturs – fell on deaf ears. As members of Congress aptly noted in a recent letter to Treasury Secretary Lew, thanks to the cavalier attitude of the OFR Report’s authors, the SEC staff ‘left little more than fingerprints,’ while their attempts to substantively improve the final product were summarily rejected.” Read the full letter here.

“Challenges for Monetary Policy Communication.” Remarks to the Money Marketeers of New York University
By Jeremy C. Stein, Governor, Board of Governors of the Federal Reserve System

“In early May 2013, long-term Treasury yields were in the neighborhood of 1.60 percent. Two months later, shortly after our June 2013 FOMC meeting, they were around 2.70 percent. Clearly, a significant chunk of the move came in response to comments made during this interval by Chairman Bernanke about the future of our asset purchase program.

“… [G]oing into the May-June period, there was a wide divergence of opinion among market participants as to the future of the asset purchase program. In particular, however reasonable the median expectation, there were a number of ‘QE-infinity’ optimists who expected our purchases to go on for a very long time. And, crucially, in asset markets, it is often the beliefs of the most optimistic investors–rather than those of the moderates–that drive prices, as they are the ones most willing to take large positions based on their beliefs. Moreover, this same optimism can motivate them to leverage their positions aggressively. In this setting, a piece of monetary policy communication that merely ‘clarifies’ things–that is, one that delivers the median market expectation but truncates some of the more extreme possibilities–can have powerful effects. Highly levered optimists are forced to unwind their positions, which then must be absorbed by other investors with lower valuations.” Read the full speech here.

“Can We End Financial Bailouts?” Remarks to the Boston Economic Club Boston
By Thomas M. Hoenig, Vice Chairman, Federal Deposit Insurance Corporation (FDIC)

“For the market to serve as disciplinarian and for bankruptcy to be a viable means for resolving systemically important financial firms, these largest, most complicated firms must become eligible for bankruptcy. Ending bailouts using the tools authorized in Dodd-Frank requires that the Living Will process be vigorously implemented. Each systemically important financial firm must provide a credible plan for orderly resolution through bankruptcy. Any institution that fails to do so should receive increased supervisory oversight and enhanced prudential standards. Ultimately, if a credible plan is not produced, supervisors should be prepared to require an institution to sell assets and simplify operations until it shows itself to be bankruptcy compliant.” Read the full speech here.

“Derivatives 2014: A Market in Transition.” Remarks at the TabbForum Event
By Scott D. O’Malia, Commissioner, Commodity Futures Trading Commission (CFTC)

“Thanks to the good work of the International Organization of Securities Commissions (IOSCO), regulators have established international standards for central counterparties (CCPs) known as the Principles for Financial Market Infrastructures (PFMIs). Today, I am sending a letter to European Commissioner for Internal Market and Services Michel Barnier that is in the same spirit of the “Path Forward Statement,” asking him to move forward with U.S. equivalence and CCP recognition under the [(European Market Infrastructure Regulation (EMIR)]… I am concerned that further delay by the European Commission (EC) in making an equivalence decision for the U.S. derivatives regulatory regime will impede the European Securities Market Authority from recognizing U.S. CCPs by this deadline.

“Without recognition, U.S. CCPs will not qualify as Qualifying CCPs (QCCPs) for purposes of the Basel III risk-weighting approach for banking institutions. U.S. CCPs will also be unable to maintain direct clearing member relationships with EU firms and will be ineligible to clear contracts subject to the EU clearing mandate next year. These scenarios would be detrimental to both U.S. and EU interests by leading to market fragmentation and contraction of liquidity, as well as market disruption and dislocation. In the spirit of international harmonization, I urge the EC to quickly resolve any outstanding issues so that equivalence and CCP recognition is achieved by June 15th.” Read the full speech here.

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