Office of Financial Research

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​The Dodd-Frank Wall Street Reform and Consumer Protection Act established the Office of Financial Research (OFR) within the Treasury Department to improve the quality of financial data available to policymakers and facilitate more robust and sophisticated analysis of the financial system.

The OFR Policy Statement on Legal Entity Identifiers has been submitted to the Federal Register for publication.

S 3005 to establish a National Finance Institute

A bill to create an independent research institute, to be known as the "National Institute of Finance", that will oversee the collection and standardization of data on financial entities and activities, and conduct monitoring and other research and analytical activities to support the work of the Federal financial regulatory agencies and the Congress.

Senate bill on finance to include agency that tracks financial risk

Senate Banking Committee members from both parties said on Wednesday that they had agreed to include in their regulatory overhaul bill a new Office of Research and Analysis that would provide early warnings of possible systemic collapses.

The proposed agency, which has sometimes been referred to as the National Institute of Finance, is intended to give federal regulators daily updates on the stability of individual firms as well as that of their trading partners, including hedge funds.

By standardizing financial instruments and reporting mechanisms, the agency would give regulators a broader view of the health of participants in the financial markets and the potential for problems to spread. The idea’s supporters say that kind of information was lacking in recent years as the housing bubble burst and troubles spread from firm to firm.

“One of the problems we observed in the recent crisis is that nobody knew who had what,” said Senator Jack Reed, a Rhode Island Democrat who last month introduced a stand-alone bill to establish a National Institute of Finance. “The result was a cascading effect of uncertainty and doubt.”

The new agency, which was also endorsed Wednesday by Senator Bob Corker, Republican of Tennessee, would have no policy responsibilities but would instead collect and analyze data, building models to assess relative risks and predict how one firm’s problems might affect others.

As proposed, the new agency would be housed in the Treasury Department with a director, appointed by the president and confirmed by the Senate, who would be an ex-officio member of a systemic risk council that would be created by the bill. The agency would draw its budget from assessments on the largest financial firms, according to people who are close to the negotiations but who were not authorized to speak publicly.

The agency would gather data from the largest firms and from a broad set of market participants, including all United States-based financial institutions, which would be required to report all their financial transactions, regardless of whether the counterparty was based here or abroad. The agency would take steps to safeguard proprietary trading information, while also shining a light onto the so-called shadow banking system of mortgage brokers, subprime lenders and unregulated hedge funds that contributed to the financial crisis.

The financial reform bill approved last year by the House would create a systemic risk council that would collect similar data without establishing an independent agency, a difference that will have to be resolved before a bill is sent to the president.

A group called the Committee to Establish the National Institute of Finance — made up of current and former financial executives, statisticians and economists, including six Nobel laureates in economics — has been lobbying for such an agency for much of the last year.

Allan I. Mendelowitz, a former director of the Federal Housing Finance Board who was a founder of the group, said in an interview that regulators were unable to assess expanding risk in the recent crisis in part because they relied on independent contractors, like the credit rating agencies, for data.

If a security was rated triple-A by the ratings agencies, for example, as were many mortgage-backed securities, regulators wrongly assumed that it posed little systemic risk, Mr. Mendelowitz said.

The agency would require a vast array of computing capacity, supporters said, and it would probably take a couple of years to establish data standards and build analytical models. But it could immediately begin to assess counterparty risk based on existing data.

Senate negotiators also tentatively agreed to establish a $50 billion fund to finance the dissolution of failing firms that could not be rescued through bankruptcy proceedings. The fund is intended to support companies that are forced to wind down their operations, without having to resort to taxpayer bailouts.

People who have been briefed on the negotiations said two proposals were under consideration. One would require financial companies to pay into a fund upfront and the other would have them buy interest-bearing shares in a trust that would allow the firms to keep the assets on their balance sheet.

Also on Wednesday, five Senate Democrats, including two members of the Senate Banking Committee, Jeff Merkley of Oregon and Sherrod Brown of Ohio, introduced a bill that would ban deposit-taking banks from owning or investing in hedge funds or private equity funds and from making market bets for the company’s own benefit.

President Obama put forward the idea in January and called it the Volcker Rule, in recognition of its champion, Paul A. Volcker, the former Federal Reserve chairman.

The bill has been endorsed by John S. Reed, a former Citigroup chairman; the economist Joseph E. Stiglitz; and Robert B. Reich, a former labor secretary, among others. But it faces significant resistance in Congress and is unlikely to be part of the revised bill that is expected to be introduced this month by Senator Christopher J. Dodd, chairman of the Banking Committee.

International regulators focus on "information gaps"

The International Monetary Fund (IMF) Statistics Department and the Financial Stability Board (FSB) Secretariat jointly organized a conference on April 8 and 9, 2010, on the Financial Crisis and Information Gaps.

Senior officials from G20 economies, other FSB members, and representatives from international institutions took part. The conference was hosted by the Bank for International Settlements (BIS) in Basel, Switzerland.

The conference was organized as part of the consultation process to develop a concrete plan of action to implement the 20 recommendations in the report “The Financial Crisis and Information Gaps,” that were endorsed at the meeting of the G-20 Finance Ministers and Central Bank Governors in St. Andrews, Scotland on November 7, 2009.

The report identified data gaps in assessing the build-up of risks in the financial sector, understanding international network connections, and monitoring vulnerabilities of domestic economies to shocks. It made recommendations to close these gaps and to improve the communication of official statistics. The report is available.

The joint conference sought participants’ views on action plans to address each of the recommendations and the required timeline. Participants discussed the pertinent issues in developing the plans, and through break-out groups discussed challenges and constraints in implementation. The conference recognized that some of the most challenging recommendations to implement--such as measuring aggregate leverage and maturity mismatches, and gaining a better understanding of financial networks--were among the most relevant for financial stability analysis.

The outcomes from the conference will inform the preparation of the progress report requested by the G-20 Finance Ministers and Central Bank Governors for their meeting on June 4 and 5, 2010. A summary from the conference will be posted on the IMF website in the coming weeks.

Information gaps

  • Source: Opening remarks by Hervé Hannoun, Deputy General Manager of the Bank for International Settlements, at the Conference for senior officials to help develop a concrete plan of action to implement the recommendations in the IMF-FSB report "The financial crisis and information gaps", prepared for the G20 Finance Ministers and central bank Governors, Basel, 8-9 April 2010.

The financial crisis exposed a number of gaps in our ability to monitor systemic risks. Addressing even a few of these may help to reduce the risk of future crises. The crisis has revealed at least five elements which matter in the monitoring of systemically important financial institutions:

  • Consolidation matters: We must enhance our ability to "see" consolidated balance sheets, both at the individual bank level and in aggregate, since it is across the whole balance sheet that stresses build up.
  • Liabilities matter: It was the collapse in funding markets which made the crisis global, and yet we cannot really see funding patterns in the available data.
  • Currency matters: Monitoring maturity mismatch at the systemic level requires information on the currency of positions, since cross-currency financing can embed rollover risk into the balance sheet.
  • Interconnectedness matters: The number and nature of an institution's bilateral relationships, and not only its size, are a key measure of its systemic importance.
  • Non-banks matter: Off-balance sheet SIVs, as well as pension funds, insurance companies and large corporates, should not be excluded from systemic monitoring exercises.

Efficiency demands that we draw on the existing reporting frameworks for our global statistics, but with better data design, and with more coordination across organisations. For its part, the BIS stands ready to help wherever possible. The BIS already collects statistics on the international activities of large banks - the so-called BIS banking and derivatives statistics - and will continue to push for improvements to these statistics.

Full speech

Thank you all for participating in today’s conference, and welcome to Basel and to the BIS. The immediate task that faces this group over the next two days is to draw up a concrete plan to implement the 20 recommendations on data gaps spelled out by the joint IMF-FSB report to the G20 last October. In my view, the broader task this group has set for itself – a rethinking and a redesign of the global data collection framework – is one of the most important things the international community can do to prevent the next crisis.

The financial crisis exposed many holes in our reporting system. Repairing even a few of these may help to significantly reduce the risk of future crises. And that, in the end, is all that we can really hope to accomplish.

To my mind, the crisis taught us at least five things which matter in the monitoring of systemically important financial institutions (SIFIs).

First, consolidation matters. We live in a world where the balance sheets of financial firms span the globe. Yet the aggregate statistics collected around the world have paid little attention to the actual geography of these firms’ operations. One must keep in mind that balance sheet stresses build up across the consolidated balance sheet, in the form of poor asset quality as well as currency, maturity or interest rate mismatches between assets and liabilities. Inability to “see” the consolidated balance sheet, either at the individual bank level or at the headquarter country level, means that the build-up of stresses at the systemic level cannot be monitored.

Thus, a key lesson of the crisis is that the appropriate unit of analysis is banks’ worldwide consolidated positions. At the level of individual institutions, some information on banks’ consolidated global balance sheets is available in their regular financial reporting, and this information is collected in BankScope and Bloomberg. However, these disclosures lack the essential breakdowns with which to measure balance sheet stresses: that is, information on the currency, maturity and counterparty type, for both asset and liability positions, along with off-balance sheet exposures. In short, the publicly available information on individual banks’ international positions falls far short of what is needed for sound monitoring.

At the national level, statistics compiled by national authorities, the IMF, the OECD and the BIS do not provide a complete picture either. For example, the flow of funds statistics, the balance of payments statistics, the IMF’s Coordinated Portfolio Investment Survey and the BIS locational banking statistics all rely on residency-based data. Such data are insufficient for identifying vulnerabilities in any particular consolidated national banking system. Currently, the BIS banking statistics come closest to providing the needed consolidated picture of banks’ international positions (for 20 or so national banking systems), albeit not at the level of individual banks.

Second, liabilities matter. It was uncertainty about the scale of losses on banks’ assets that was the proximate cause of the crisis. However, it was the dislocations in banks’ funding markets that made this a global crisis. Funding in the interbank market, and from non-bank money market funds, became impossible for all but the shortest terms; funding in the repo market became available only against high-quality collateral; and funding in the swap market became much more expensive. In short, major dislocations occurred in every important short-term funding market. Yet we cannot really “see” any of these markets in our aggregate data. And when we cannot see them, we cannot assess the degree of maturity mismatch embedded in the system.

Third, currency matters. The funding crisis was really a crisis of dollar funding. The flaw in the funding models of so many banks was that they failed to appreciate the hidden vulnerabilities in the excessive maturity mismatch in their funding of US dollar assets. The off-balance sheet borrowing of dollars through FX swaps that they relied on covered the exchange rate risk. But the short-term tenor of these instruments left them vulnerable to rollover risk, and liquidity in this market was simply taken for granted. No measure of effective maturity mismatch is possible if cross-currency funding positions are not taken into account.

Fourth, interconnectedness matters. The degree of interconnectedness of a particular financial institution – and not only its size – is a key indicator for measuring systemic importance. To measure this, we need information on bilateral interbank liabilities, and on the system-wide aggregate exposures to particular counterparties. But such data on bilateral exposures are reported only to supervisors because of confidentiality and legal restrictions.

Fifth, non-banks matter as well. Off-balance sheet entities such as structured investment vehicles (SIVs) obscured the build-up of stresses in the financial system, and they exacerbated the problems when they had to be moved back onto banks’ balance sheets. Moreover, other non-banks – in particular, pension funds, insurance companies and large corporates – should not be excluded from systemic monitoring exercises.

Without the ability to see, at various levels of aggregation, the on- and off-balance sheet consolidated positions of large bank and non-bank financial firms, and at least some measures of the maturity mismatch on their balance sheets, we cannot hope to really understand the risks at a systemic level.

Of course, new and better data come with new and possibly higher costs, many of which will be borne by taxpayers and reporting firms around the world. The concrete agenda which ultimately emerges here must bear this fact in mind.

Each of the organisations represented in this room already collects and disseminates data covering some important piece of the international financial system. Much of these data ultimately come from reporting agencies in member countries. Efficiency demands that we draw on the existing reporting frameworks for our global statistics, but with better data design, and with more coordination and sharing of information across organisations.

For its part, the BIS stands ready to help wherever possible. The BIS already collects and disseminates statistics on the international activities of large banks – the so-called BIS banking and derivatives statistics. These statistics cover the international activities of more than 7,000 reporting entities – or roughly 95% of all international bank assets – and are based on underlying data reported by more than 40 central banks. This BIS / central bank reporting framework has functioned smoothly for more than 30 years, giving the BIS considerable experience in the handling of confidential international banking data. This framework has also proved to be flexible, leading to improvements to the reported data, including derivative exposures. The BIS, along with the CGFS, will continue to push for improvements to these banking and derivatives statistics.

To conclude, we look forward to two days of productive discussions, and I wish you all the best for a successful event. Thank you for your attention.

Euro regulators assess trade transparency and reporting

Oversight and transaction reporting to regulators

Q11: In view of its work on transaction reporting of OTC derivatives and on trade repositories, please assess:

  • Q11(a): How best to arrange the flow of information to be provided by investment firms to regulators for transaction and position reporting purposes? Please consider the objective of minimising any double reporting for investment firms;
  • Q11(b): Apart from detecting and pursuing cases of market abuse, what other purpose does transaction reporting have? What purpose does position reporting have?
  • Q11(c): What are the experiences of CESR with transaction reporting by regulated markets, MTFs or trade-matching or reporting systems by pursuant to Article 25(5) MiFID?

Goldman Sachs and Morgan Stanley are backing a quasi-governmental group

"The financial markets are surely as important and as complicated as the weather, yet we don't have an equivalent of the National Weather Service or the National Hurricane Center in the financial markets," says John Lietchy, Associate Professor of Marketing and Statistics, Pennsylvania State University.

Lietchy is one of a group of volunteers — Wall Street executives and former regulators as well as academics — that are working to set up a National Institute of Finance that would gather market, trade and derivative data from all large Wall Street players in the interest of getting a clear picture of systemic risk.

"If you take the events that happened at AIG last year, when everybody began to understand what they had on their books, it turned out they had $3 trillion in notional value outstanding in credit default swaps," Lietchy says. "That's a concentration that's not OK. It's very dangerous. The risk is when AIG disappears, suddenly all those assets people have on their books, which have been increasing in value, have to be taken off their books. And once you take that $3 trillion notional value off of everybody's books, you ask yourself, who's depending on those contracts on their books to keep themselves solvent? If you see anybody who's not solvent, you have to take them out of the picture and look at all their counterparty relationships and ask the same question. It could cascade, and the only way to have systemic regulation that really understands the systemwide risk is to have an overseer who understands all the major positions, the algorithms the financial institutions have taken."

Although one might assume that the last thing most Wall Street firms would want is more reporting rules and a new regulatory entity, Morgan Stanley and Goldman Sachs both support this effort. An executive at one bulge-bracket firm (who did not wish to be identified) explains that this data gathering and analyzing entity would benefit Wall Street firms in two ways. "One is, when you standardize data and the reference names, you greatly reduce operational breakage and operational risk," he says. "Operational breakage can cost a large firm hundreds of millions of dollars a year." Trades can be reconciled and cleared more quickly with everybody using the same reference data.

The other advantage Wall Street firms see in creating a National Institute of Finance is that they recognize that during the market disruptions of last year many firms came close to no longer existing. "A well functioning capital market is how we make money," the Wall Street executive says. "In this disruption, trading almost ceased, credit dried up like mad. We lost client base. That's not good for us. It takes a while to recover from there."

Under the draft legislation for which the NIF committee is seeking a Senate sponsor (and hopes to get it tacked on to the omnibus regulatory reform bill), large firms would copy all trade data at the end of each day to the NIF. The NIF would have a research and analytics group that would examine market dynamics and the flow of credit and risks through the markets, performing "what if" analyses such as, what if one particular bank failed, how would that affect everyone else? The analytics group would build metrics that would be calculated to provide a continuing view as to whether risk is building up in the system, whether it's concentrating in a particular sector of the system, how much of the risk is sitting inside banks, how much risk sits outside the banks. Some of this research might be performed in the academic environment.

The NIF would not be a regulatory agency, it would be a service agency for existing regulators. "We're not going to impose rules, we're not going to announce warnings of the marketplace," the Wall Street executive says. "The only authority it will have will be to collect data, produce referentials and maintain data standards. We're not going to have the authority to say you have to increase your capital or decrease your capital or or your models don't work or do work. That's the responsibility of whoever the supervising regulator is." Do existing regulators, such the SEC and FINRA, have the technical competence to make savvy use of this pipeline of new research?

"There are a lot of challenges with the way the securities market was and is regulated," says Lietchy. "That's in the process of being changed. But nobody was really being held responsible for all of that. It's very hard to get a good picture of the system if you don't have granular data that you control and your own analytics. The fact that the regulators have to turn to the banks to ask them to do stress tests, they have to outsource the assessment of the industry and the strength and health of those institutions to the rating agencies, indicates that there's a core competency that needs to be there." The information the NIF would collect, he says, would allow regulators to see more of what's going on. "It would allow you to answer important questions like what is systemic risk, what aggregations are too big, when are firms going to be too big, too interconnected to fail?"

Firms would not have access to any of the information the NIF collects, so no firm would be able to look at the trading positions of another. They would need to share standardized reference data, so that every firm would use the same set of legal entity names.

The efforts firms would need to make to adjust to this standardization and automated trade reporting system would help them manage risk, Lietchy says. "Once you put this system in place to report everything back to the government, everybody will be able to do their own risk management with a much better set of data," he says. "They won't have to say, LTCM went down, Lehman went down, what's our exposure? And take weeks to figure it out. It will take them hours if not minutes. By putting their house in order, they will make risk management easier because they will no longer have these exposures sitting on a spreadsheet or a paper document.


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