Author Archives: Bristol Voss

CFA Institute Systemic Risk Council Publishes Fall Newsletter

For further information contact Kurt Schacht at Kurt.schacht@cfainstitute.org.

WASHINGTON, D.C.— November 7, 2022 The CFA Institute Systemic Risk Council today released its Fall 2022 Newsletter.

Each quarter, we will recap the activities of the CFA Institute Systemic Risk Council (SRC or the Council) and highlight the key systemic debates and challenges affecting global markets and regulators. We find ourselves in unprecedented times both in terms of quantity and frequency of major financial disruptions that test the resiliency of our global financial systems. The private sector Council represents an independent, noncommercial voice on matters of growing and urgent systemic concern. We provide an expert and clear assessment of the readiness of our regulatory institutions to deal with evolving systemic vulnerabilities and advocate for prompt action when improvements in detecting, monitoring, and responsiveness are needed to meet systemic risk threats.

Topics covered in the current newsletter are:

  • EC DG for Financial Stability Weighs in on Global Risk Issues
  • US Regulators: Urgent Need for Crypto Regulatory Action
  • SRC Members Weigh in on Systemic Risk Issues
  • Recent News on Systemic Risk Issues

LINK: https://www.systemicriskcouncil.org/2022/11/cfa-institute-systemic-risk-council-publishes-fall-newsletter/

CFA Institute Systemic Risk Council Q2:2022 Newsletter

Welcome to the spring edition of the Quarterly Systemic Report! Each quarter,
we will recap the activities of the CFA Institute Systemic Risk Council (SRC or the
Council) and highlight the key systemic debates and challenges affecting global markets
and regulators. We find ourselves in unprecedented times both in terms of quantity and
frequency of major financial disruptions that test the resiliency of our global financial
systems. The private sector Council represents an independent, noncommercial voice on
matters of growing and urgent systemic concern. We provide an expert and clear
assessment of the readiness of our regulatory institutions to deal with evolving systemic
vulnerabilities and advocate for prompt action when improvements in detecting,
monitoring, and responsiveness are needed to meet systemic risk threats.
We welcome your feedback — and look forward to keeping you informed of the key
economic twists and turns affecting the resilience and stability of the global economy.

LINK: http://www.systemicriskcouncil.org/wp-content/uploads/2022/04/Quarterly-Systemic-Report-April-2022_DRAFT3.pdf

Topics covered:
• New Council Co-Chairs Provide Global, Independent Direction
• Comment Letter: SRC Urges Regulatory Action on Stablecoins
• Comment Letter: Money Market Funds—Third Time’s a Charm?
• Climate Change: Focus on Climate and Systemic Risk Effects
• Sustainability Reporting: New Climate Reporting Proposals for Public Companies
• Global Conflict: Ukraine Conflict Implications on Systemic Risk

LINK: http://www.systemicriskcouncil.org/wp-content/uploads/2022/04/Quarterly-Systemic-Report-April-2022_DRAFT3.pdf

CFA Institute Systemic Risk Council Writes in Support of the US SEC Proposed Rules for Money Market Funds

Letter to the US SEC

April 15, 2022

Re: Release No. IC–34441; File No. S7–22–21

Dear Members of the Commission:

We write in support of the proposed amendments to the Commission’s rules governing money market mutual funds. We believe that the Commission’s plan to increase the daily and weekly minimum liquid asset requirements to 25% and 50% respectively and to require institutional prime and institutional tax-exempt money market funds to implement swing pricing policies and procedures will enhance resilience, shift the liquidity costs of redemptions to redeeming investors (where they belong), and reduce the likelihood of damaging financial panics. We also believe that the Commission should remove the liquidity fee and redemption gate rules that it promulgated in 2014, as we saw in 2020 that the gates and fees exacerbated rather than mitigated run risk.

            We expect that aspects of the new proposed framework, especially swing pricing, will be difficult to implement, and that even if the framework is fully and effectively implemented, the risk of future destabilizing runs may not be eliminated. Given the significant externalities associated with these runs, we believe that the Commission should also enhance its stress testing procedures and, if the above measures prove unsuccessful, consider imposing capital requirements. While prime money fund sponsors may protest the cost of these measures, including swing pricing, it is not the task of the Commission to ensure that operating prime money funds is a profitable business. Rather, it is the Commission’s responsibility to protect investors and ensure that mutual fund sponsors internalize the costs associated with their activities. As the Commission is well aware, there is a robust market for government money funds organized pursuant to 17 C.F.R. § 270.2a-7(a)(14)—with over $4 trillion outstanding as of December 31, 2021. These money funds offer investors a safe and efficient way to use the investment company structure for cash management and related purposes. If, after implementing reforms to address as efficiently as possible the costs imposed by prime money funds on investors and other market participants, it turns out that safe prime money funds are not economical, then it would be appropriate for these funds to cease operations.

  1. Prime Money Funds Externalize Costs

Prime money market funds—those that do not invest 99.5 percent or more of their total assets in cash, government securities, or fully collateralized repurchase agreements—have a dual character. Formally, they are investment companies, registered with the Commission under the Investment Company Act and subject to regulation by the Commission under 17 C.F.R. § 270.2a-7. Functionally, they are banks, albeit ones with a narrow business model and highly liquid, short duration, high quality assets.[1] Like banks, money funds issue claims that are used as money or close substitutes for money. Their shares function this way due to their redemption practices and asset portfolios—and until 2014, the fact that they offered investors a stable net asset value.[2]

Unfortunately, to the extent that investors treat money fund shares as alternative forms of money, they expect something that funds cannot deliver, namely, par convertibility through the business cycle. As with other forms of “private money,” money market fund shares are money-like during good times, but when economic and financial conditions deteriorate, they break par with government-issued cash in the absence of official sector support. Accordingly, as the possibility of non-par convertibility approaches, institutional investors in money fund shares tend to run for the exits, regardless of whether a fund’s underlying assets are likely to meaningfully depreciate in value. The result is harm to the fund’s non-redeeming investors, fire sales, contagion, credit market disruptions, and sharp contractions in economic activity.[3] These sorts of dynamics, when spread widely enough across the monetary system, trigger acute macroeconomic disasters. For example, these sorts of runs led to the Great Depression.[4] The Great Recession of 2008 was “great” for a similar reason,[5] with runs on a wide range of alternative forms of money, and its costs were substantial.[6]

Regulators’ failure to address the gap between what investors expect from money funds and what money funds are able to deliver—and, in the past, their active efforts to facilitate this arbitrage—led to a ballooning money market fund sector in the 2000s, which culminated in runs on money funds in 2008 and a massive $4 trillion government guarantee. Subsequently, the Commission attempted to close the gap. Its 2010 rules imposed liquidity requirements, reducing the maximum weighted average maturity of fund holdings. Its 2014 rules adopted a floating net asset value and authorized liquidity fees and redemption gates, prompting many investors seeking deposit-like forms of cash to shift away from prime money funds. Accordingly, assets in prime funds fell from over $1.5 trillion to around $500 billion.[7] But as the Commission acknowledges, the 2014 rule change did not entirely solve the problem. The remaining prime money funds were once again a source of financial instability in March 2020. And official sector intervention, including $50 billion of direct support from the Federal Reserve, was once again required to prevent money funds from harming the wider economy.[8]

  1. The Proposed Rules Would Internalize Costs Imposed by Money Funds

The Commission’s proposal marks an important step toward ensuring that money fund sponsors and investors internalize the costs of their products. Two aspects of the noticed amendments bear emphasis.

  1. Increasing Liquidity Requirements

First, the Commission’s plan to increase portfolio liquidity requirements will meaningfully enhance the ability of funds to manage significant and rapid investor redemptions making such redemptions less harmful to non-redeeming investors and less likely in the first place. As we saw in March 2020, the current requirements—daily liquid assets of 10% and weekly liquid assets of 25%—are still too low. While policy makers cannot calculate the appropriate level with precision ex ante—because the level is a function of unquantifiable metrics such as market perceptions, historical experience, the prospects and expected severity of financial and economic disruption, as well as the other measures in place to force plan sponsors and redeeming investors to bear the full costs of redemption[9]—the volume of redeeming investors in March 2020 suggests that the proposed levels (daily liquid assets of 25% and weekly liquid assets of 50%) are, if anything, too low.[10] Yet further increases may be warranted if prime money funds exhibit run dynamics during periods of economic uncertainty in the future.

  • Replacing Gates and Fees with Swing Pricing

The Commission’s proposal to replace gates and fees with swing pricing is a second important and salutary adjustment to the regulatory framework. The Commission’s adoption of a floating net asset value—aligning the regulatory treatment of money funds with the regulatory treatment of all other investment companies—was a meaningful step toward eliminating the externalities associated with prime money funds. However, due to the costs of redemption and the investors’ ability under the existing rules to avoid liquidity fees by redeeming prior to a fund’s decision to impose such fees, the current regulatory framework does not fully ensure that every redeeming investor receives value that actually represents the investor’s pro rata economic interest in the fund’s assets.[11] In other words, even with floating NAV, early redeemers are still able to shift costs to non-redeemers. Swing pricing offers enhanced floating NAV or floating NAV+.

Swing pricing is complex and will be challenging to administer. But this complexity reflects the complexity of the underlying problem associated with the prime money fund business model. Among other things, even with swing pricing, early redeemers may get a better price which will create incentives for money fund investors to get out quickly.[12] It is possible, although we think unlikely, that correcting for the externalities imposed by prime money funds on other investors and the broader economy will be so costly as to make prime money funds uneconomical to operate. Under the law, that would not be a reason to shy away from appropriate regulation. The Commission is obligated to carry out the goals of the statutory scheme as efficiently and effectively as it can and let market participants determine how to organize their investment companies and invest their portfolios in light of the appropriate regulatory framework.

It is worth noting that it could exacerbate threats posed by money funds to U.S. financial stability were the Commission to remove gates and fees without replacing them with swing pricing or some similar scheme. While, gates and fees exacerbate run dynamics ex post, they potentially reduce the likelihood that investors seeking instruments that behave like bank deposits or cash will select prime funds ex ante.

  1. Further Reforms Merit the Commission’s Consideration

Given the high costs to investors and other market participants of runs on prime money funds, the Commission should also enhance stress tests and, if the above measures prove unsuccessful, consider imposing capital requirements.

  1. Enhancing Stress Tests

The Commission should also consider further strengthening money fund stress tests, which the Commission imposed in 2010 and strengthened in 2014.[13] The existing regime does not conform to best practices for stress testing. Among other things, neither the funds nor the Commission disclose to investors the scenarios or the results. Accordingly, the market lacks the tools to determine whether the tests are appropriately calibrated, reducing the usefulness of the exercise with no apparent benefit.

  • Exploring Capital Requirements

If the above measures prove unsuccessful, the Commission should consider imposing capital requirements. As the Council,[14] and leading independent experts, have noted, capital could help absorb losses in a crisis period.[15] While most prime money funds are invested in highly liquid and short-dated assets and therefore do not need the level of capital maintained by commercial banks,[16] some minimum capital level may be justified to the extent other reforms, such as the ones currently under consideration, fail to achieve their goals.

  1. Conclusion

In sum, we commend the Commission for pursuing these important amendments to the regulatory framework governing money market funds. Recent events demonstrate that ex post liquidity fees and gates are inadequate to prevent dangerous runs. Enhanced ex ante liquidity requirements and swing pricing are needed to reduce the externalities associated with prime funds. Enhanced stress testing should also be considered, along with, if necessary, capital requirements. Of necessity, these measures will increase costs for funds and lower returns for their investors during normal times. These costs, however, are not a reason for the Commission to dial back its amendments. To the contrary, given the comparatively larger costs of monetary instability, reforms are needed even if they reduce the viability of unstable investment company business models.

Respectfully submitted,

Simon Johnson and Erkki Liikanen

on behalf of the Systemic Risk Council


[1] The functional similarity between prime money funds and banking has been long recognized. See, e.g., Testimony of Paul A. Volcker, Chairman, Board of Governors of the Federal Reserve System, Federal Reserve Membership, Hearings Before the Committee on Banking, Housing and Urban Affairs, 96th Cong., 1st Sess., at 24-26 (Sept. 26, 1979); John A. Adams, Money Market Mutual Funds: Has Glass-Steagall Been Cracked?, 99 Banking L.J. 4 (1982); Jonathan R. Macey & Geoffrey P. Miller, Nondeposit Deposits and the Future of Bank Regulation, 91 Mich. L. Rev. 237, 256–60 (1992). It is arguably a consensus position today among independent experts. See, e.g., Gary Gorton & Andrew Metrick, Regulating the Shadow Banking System, Brookings Papers on Economic Activity 261, 269–70, 284–85 (2010); Board of Governors of the Federal Reserve System, Money and Payments: The U.S. Dollar in the Age of Digital Transformation 27 (2022) (“the global financial crisis in 2008 was in large part a crisis of nonbank money, and nonbank money contributed to financial strains again at the onset of the COVID-19 pandemic”).

[2] One formal difference between a bank deposit and a money fund share is that the former is debt and the latter is equity. But there is no reason why an alternative form of money has to be structured as a debt instrument. The essential feature of alternative forms of money is convertibility at or very close to par, which can be achieved by debt or equity backing.

[3] For an overview, see Morgan Ricks, The Money Problem: Rethinking Financial Regulation 102–42 (2016).

[4]  See, e.g., Ben S. Bernanke, Non-Monetary Effects of the Financial Crisis in the Propagation of the Great Depression, 73 Am. Econ. Rev. 257 (1983).

[5] Ben S. Bernanke, The Real Effects of the Financial Crisis, Brookings Papers on Economic Activity (Sept. 13-14, 2018) (concluding that the unusual severity of the Great Recession was due primarily to the panic in money markets, which disrupted the supply of credit).

[6] Tyler Atkinson et al., How Bad Was It? The Costs and Consequences of the 2007-09 Financial Crisis, 20 Fed. Res. Bank of Dallas Staff Papers 1, 2 (2013) (estimating the cost at $6 to $14 trillion); Andrew Haldane, The $100 Billion Question, Remarks at the Institute of Regulation and Risk Conference, Hong Kong (Mar. 30, 2010) (suggesting that the cost of the 2008 crisis may have been between $60 trillion and $200 trillion for the global economy as a whole, with 1-5 times annual GDP lost in the US alone).

[7] 86 F.R. 8942 (Feb. 10, 2021) (Chart 1).

[8] Jeanna Smialek, Money Market Funds Melted in Pandemic Panic. Now They’re Under Scrutiny, N.Y. Times (Apr. 27, 2021).

[9] For a theoretical explanation for why conventional cost benefit analysis is unable to effectively aid policy making in circumstances like these and can, in fact, lead to serious policy errors, see Jeffrey N. Gordon, The Empty Call for Benefit-Cost Analysis in Financial Regulation, 43 J. of Leg. Stud. 351 (2014).

[10] For example, in March 2020 the largest daily outflow was around 26% and the largest weekly outflow was around 55%. But this period also featured an official sector intervention of unprecedented scale. See Stephen G. Cecchetti & Kermit L. Schoenholtz, SEC Money Market Fund Reform Proposals Fall Far Short, Again, Money & Banking (Jan. 28, 2022). Moreover, as of year-end 2021 daily liquid asset levels for prime institutional funds averaged 53%, more than twice the new proposed minimum. SEC Division of Investment Management, Money Market Fund Statistics (Jan. 14, 2022).

[11] Jeffrey N. Gordon & Christopher M. Gandia, Money Market Funds Run Risk: Will Floating Net Asset Value Fix the Problem?, 2014(2) Columbia Bus. L. Rev. 314 (2014).

[12] These dynamics underline the importance of increasing liquidity requirements or imposing capital requirements, which are easier to administer.

[13] See Rule 2a-7(j).

[14] The Systemic Risk Council, No. S7-01-21, Release No. IC-34188 (Apr. 12, 2021), at 6–7 (“funds . . . need to be required to issue capital instruments of some kind that will absorb losses ahead of those investor claims that rely upon being liquid and safe”).

[15] See, e.g., Martin N. Baily; John Y. Campbell; John H. Cochrane; Douglas W. Diamond; Darrell Duffie; Kenneth R. French; Anil K. Kashyap; Frederic S. Mishkin; David S. Scharfstein; Robert J. Shiller; Matthew J. Slaughter; René M. Stulz, Money Market Fund Reform, Number S7-03-13 (September 17, 2013); Stephen G. Cecchetti & Kermit L. Schoenholtz, SEC Money Market Fund Reform Proposals Fall Far Short, Again, Money & Banking (Jan. 28, 2022).

[16] Samuel G Hanson, David S Scharfstein & Adi Sunderam, An Evaluation of Money Market Fund Reform Proposals, 63 IMF Econ. Rev. 984-1023 (2015) (concluding that a capital requirement of four percent or less would be appropriate for prime institutional funds and would lower returns to ordinary shareholders by just five basis points).

For full letter see: http://www.systemicriskcouncil.org/wp-content/uploads/2022/04/SRC-MMF-Letter-4.15.2022_final.doc.pdf

Stop Financing Putin’s War

Every day, the European Union, the United Kingdom, and the United States send Russia an average of $500 million for oil and gas. But there is good reason to believe that Russia could not withstand an embargo on its energy products.

WASHINGTON, DC – On February 24, the first day of the full-scale invasion of Ukraine, the West paid Russia about $500 million. That’s the average daily value of purchases of Russian energy by the European Union, the United Kingdom, and the United States. As the conflict continues, the daily flow of cash has remained about the same. Europe, in particular, is effectively financing Russian aggression, the destruction of lives and livelihoods, and the creation of a massive refugee crisis. Why?

The short answer is that the West has been slow to recognize the full danger of Russian President Vladimir Putin’s intentions. For millions of Ukrainians, the continuing flow of money is fueling tragedy.

The strength – and weakness – of Russia’s economic position is evident from its foreign-trade statistics, which were analyzed in a working paper published this month by the Bank of Finland Institute for Emerging Economies. Most of Russia’s exports are oil, petroleum products, and gas ($240 billion in 2019), and over half go to the EU. The rest of Russia’s exports combined ($48.5 billion) amount to less than the value of its gas exports ($51 billion).

China buys 28% of Russia’s oil, but only 5% of its petroleum products and 1.1% of its gas. The EU buys 63.9% of Russian gas and the UK buys another 4.5%.

To be sure, disconnecting selected Russian banks from the SWIFT messaging system will make it more cumbersome for Russian companies to get paid for European energy deliveries. But payment through telex, telephone, other networks, or third parties provides fallback options.

The obvious solution is to stop paying for Russian gas altogether – or to pay into an escrow account until Russia withdraws its forces to its pre-February 24 borders. The Russian reaction presumably would be to shut off deliveries, but Europe claims to have enough stocks to get through this winter, so this is partly about the costs of preparing for next winter.

Those costs are likely to be high, because any disruption to world energy supplies typically drives up the price of oil or gas, or both, which would presumably affect the EU, the US, and the global economy more broadly. It would also complicate central banks’ task of controlling inflation. But policymakers have dealt with bigger issues, including the COVID-19 crisis in 2020-21 and the global financial crisis in 2008.

Germany’s energy strategy has relied on Russian gas since the 1960s. But while deliveries proved reliable throughout the remainder of the Cold War and the aftermath of the Soviet Union’s collapse, it is no longer a sustainable arrangement. Putin’s rationale for launching all-out war against Ukraine – to reimpose Soviet-era borders – has existential implications for the EU’s ex-Soviet members, Estonia, Latvia, and Lithuania. Business as usual is – or should be – out of the question.

The impact of denying Russia its daily inflow of foreign cash depends on whether it could use its accumulated foreign-exchange reserves to buy needed imports, which cost $380 billion (25% of GDP) in 2021. To pay for imports from a Western country, you need euros, dollars, or another Western currency. Italian or French exporters are unlikely to accept payment in gold, Chinese renminbi, or cryptocurrency.

The Central Bank of Russia has been preparing: reserves reached a record high of $638.2 billion on January 14. And, unlike most central banks, since 2018 the CBR has held relatively little of its reserves in US Treasury securities at the Federal Reserve Bank of New York.

But does that mean Russia could outlast an EU-led embargo on its energy products? US sanctions obviously can prohibit any US bank or other entity from dealing with Russian companies or the official sector, and some first steps were announced on February 24. Less well understood is that properly designed “secondary sanctions” can also prohibit US banks from clearing transactions that are arranged by third parties on behalf of Russia. To be effective, steps in this direction would need to be matched by the eurozone authorities, as well as by the UK.

Although the EU intends to sanction the CBR, the measures remain unclear. What is clear is that enforcement will be a challenge, because no one knows exactly where the CBR is holding its reserves. Credible reports suggest they are hidden in opaque offshore markets, perhaps through transactions with EU or Swiss banks. According to Zoltan Pozsar of Credit Suisse, half of all Russian reserves may be held in dollars, concealed using foreign exchange swaps. These spot sales and forward purchases of US dollars mean that the CBR is effectively lending dollars against collateral denominated in other currencies. If true, this is further confirmation that the CBR needs access to dollars for its transactions.

Pozsar is concerned that sanctions or the threat of sanctions could rattle funding markets. This issue requires immediate attention from the US Federal Reserve, working with the Financial Stability Board and other relevant authorities. Again, policymakers have dealt with bigger shocks in recent decades.

In addition, Russia should be suspended immediately from the International Monetary Fund. That would send a clear signal to financial and currency markets that Russia will not be able to draw on its reserves held in the form of Special Drawing Rights.

To be sure, these measures would amount to a radical departure from post-war norms. But Putin tore up those norms on February 24.

EDITOR’S NOTE: This article first appeared on Project Syndicate: The World’s Opinion Page on 28 February 2022. It represents the opinion of Simon Johnson, Co-Chair of CFA Institute Systemic Risk Council

Photo credit: Getty Images Stock Photo

CFA Institute Systemic Risk Council Adds New European Members

Washington D.C. –  February 22, 2022

Today, CFA Institute Systemic Risk Council (SRC) announced that Marina Brogi of Italy, Andreas Raymond Dombret  of Germany, and José Manuel González Páramo of Spain have joined the Council.

Erkki Liikanen, Co-Chair of the Council said, “We are thrilled to add these three very talented and experienced people to the Systemic Risk Council, broadening our European representation and adding important international perspectives to our Council discussions.”

Ms Brogi is an Italian economist, Full Professor of Banking and Finance at Sapienza University of Rome, where she also served as Deputy Dean of the Faculty of Economics (2011-2017). She teaches International Banking and Capital Markets as well as Corporate Governance in graduate, MBA, PhD and executive courses at Sapienza University and other universities in Italy and abroad. From January 2014 to June 2016, she was one of the 5 top-ranking independent academics appointed to serve on the Securities and Markets Stakeholder Group of the European Securities and Markets Authority (ESMA). In addition, Ms Brogi has served on various Bank of Italy governance bodies responsible for crisis procedures of banks and at Consob in the selection committee in numerous public competitions, among other prestigious assignments.

Mr. Dombret is German-American banker and was a member of the executive board of Deutsche Bundesbank from 2010 until 2018. From 2014 until 2018 Andreas served on the Supervisory Board of the ECB, and from 2012 until 2018 on the Board of the BIS. Earlier in his career, Andreas was Vice Chairman of Bank of America in EMEA, co-head of Rothschild Germany and Managing Director at JP Morgan in London and Frankfurt, having started his career at Deutsche Bank. After retiring from public office, Andreas Dombret assumed a portfolio of advisory mandates at various firms including Oliver Wyman, Santander, Sumitomo Mitsui Bank and Houlihan Lokey. He teaches at Columbia University and at the European Business School.

Mr. González-Páramo is a Spanish economist who served as a member of the Executive Board of the European Central Bank (ECB) from 2004 until 2012. In June 2013 he was appointed Executive Board member of Banco Bilbao Vizcaya Argentaria, S.A. (BBVA), one of the largest financial institutions in the world, and is present mainly in Spain, South America, North America, Turkey, and Romania. Before that he served as an Executive Board member of Bank of Spain, from 1994 to 2004. From 1985 to 1994 González-Páramo was an economic adviser to various public and private institutions including the Banco de España (1989–1994), the European Commission, the IMF and the World Bank Group. He is a professor of Economics at IESE Business School and the Chairman of the Supervisory Board of European DataWarehouse.

Welcoming the appointments, SRC Co-Chair Simon Johnson said, “I am absolutely thrilled these distinguished experts will be joining our systemic risk discussions. They bring a wealth experience and diverse perspectives to this important work.”  The appointments are effective immediately and bring the Council to a total of seventeen members. 

The Council is committed to engaging with U.S., European, and other global policy makers at the highest levels in order to preserve a stable financial system. For more on the SRC go to www.systemicriskcouncil.org

CFA Institute Systemic Risk Council Urges FSOC to Address the Risks to U.S. Financial Stability Posed by Unregulated and Underregulated Stablecoins

We write to urge the Financial Stability Oversight Council (FSOC) to address the risks to U.S. financial stability posed by unregulated and underregulated stablecoins. The President’s Working Group on Financial Markets, along with the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), recently released a report recommending that Congress address these risks by passing new legislation that would impose needed regulations on stablecoin issuers and the stablecoin market. We agree with this report that a legislative response would help mitigate threats posed by unregulated stablecoins. We also believe that such legislation could help address risks posed by other underregulated monetary instruments. Full text of the letter below or here: http://www.systemicriskcouncil.org/wp-content/uploads/2022/02/Stablecoin-Letter-v12-Feb-17-2022.pdf

The Honorable Janet L. Yellen

U.S. Department of Treasury

1500 Pennsylvania Avenue, N.W.

Washington, D.C. 20220

February 17, 2022

Re: Risks to Financial Stability Posed by Unregulated Stablecoins

Dear Chair Yellen and Members of the Financial Stability Oversight Council:

            We write to urge the Financial Stability Oversight Council (FSOC) to address the risks to U.S. financial stability posed by unregulated and underregulated stablecoins.[1] The President’s Working Group on Financial Markets, along with the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC), recently released a report recommending that Congress address these risks by passing new legislation that would impose needed regulations on stablecoin issuers and the stablecoin market.[2] We agree with this report that a legislative response would help mitigate threats posed by unregulated stablecoins. We also believe that such legislation could help address risks posed by other underregulated monetary instruments.[3]

But there is a significant chance that Congress will not act in time. The supply of unregulated stablecoins is growing fast. Total dollar denominated stablecoins are up 500% over the past year and now exceed $140 billion.[4] Today, the balance sheet of the largest unregulated stablecoin issuer—Tether Limited—is larger than the Reserve Primary Fund was when it broke the buck in 2008.[5] Given the uncertainties and delays involved in the legislative process, policymakers should simultaneously pursue the other routes.

Fortunately, Congress has provided the FSOC, its member agencies, and other government bodies with a set of tools that—while somewhat cumbersome to employ—can help prevent unregulated stablecoins from threatening the stability of the U.S. financial system.[6] We propose that the FSOC coordinate the use of these tools by creating a working committee on stablecoins[7] and attempting to bring stablecoins within the regulatory perimeter.

We recommend a two-pronged strategy. First, the FSOC should designate all stablecoins as systemically important payment, clearing, and settlement activities. Second, the FSOC should work with its member agencies, including the banking regulators, the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and the Consumer Financial Protection Bureau (CFPB), to use their authorities to regulate stablecoins. Regulators’ overarching goal should be to limit or eliminate the use of fractional reserve stablecoins—ledger entries that are not backed one-for-one with insured bank deposits or short-term U.S. government debt—and thereby reduce the risk of runs, contagion, and further expansion of the shadow banking sector.

The FSOC should also open an international dialogue with foreign monetary and stability authorities regarding stablecoins. Many stablecoin operators are located overseas, including the largest, Tether Limited. Stablecoins can also be used to facilitate value transfers internationally, which raises policy issues for global payments system design. FSOC and its member agencies ought to work to harmonize standards for all stablecoin issuers worldwide and ensure that efforts by U.S. regulators to address risks posed by stablecoins domestically do not lead destabilizing activities to move offshore.

  1. Title VIII Designation

In response to the 2008 financial crisis, Congress mandated, in Title VIII of the Dodd-Frank Act, that the FSOC “designate those financial market utilities or payment, clearing, or settlement activities that [it] determines are, or are likely to become, systemically important.”[8] Accordingly, we believe that the FSOC should designate stablecoins, including those that are fully reserved, as likely to become systemically important payment, clearing, and settlement activities, subjecting involved parties (including issuers and wallet providers) to enhanced regulatory oversight. This would permit the Federal Reserve to promulgate risk management standards governing capital, liquidity, policies and procedures, and clearing and settlement.[9]

Stablecoins today are already complex payment, clearing, and settlement activities within the meaning of the law, and their rapid growth over the past year supports a determination that they are “likely to become” systemically important.[10] Regulation to ensure operational integrity is essential.[11] New rules are also needed to require stablecoin issuers to fully reserve against their liabilities. Fractional reserve stablecoins pose run risk that could trigger future panics and the possibility of a self-reinforcing cycle of runs and fire sales that spread to other issuers and asset classes. For example, a run on a stablecoin that holds substantial amounts of commercial paper[12] could prompt a self-reinforcing cycle of runs and fire sales that spreads to other issuers and asset classes.[13] Such panics have driven most acute macroeconomic disasters in American history. By tightening credit and shrinking the money supply, they trigger sharp declines in economic activity, layoffs, and bankruptcies.[14] The FSOC must not wait until a run on fractionally reserved stablecoin issuers triggers a repeat of the 2007-08 panic.[15]

As the regulators’ recent report recognizes, Title VIII designation is, in certain respects a second-best solution. Ideally, entry into fractional reserve stablecoins would require a bank charter, and unchartered issuers could be sued by one of the banking agencies in the same way that the SEC routinely prevents evasion of the securities laws by pursuing arrangements that are functionally equivalent to securities.

In 1933, Congress passed landmark legislation designed to do this. The relevant provision, Section 21(a) of the Banking Act, prohibits unauthorized persons from engaging in the business of receiving deposits subject to repayment “upon request of the depositor.”[16] Section 21(a) requires that, at the very least, companies engaged in such a business be examined and regulated by a state banking authority. It thus establishes a regulatory perimeter for money and banking. But while other regulatory regimes, like those for securities, empower a single agency to enforce the law, in money and banking there is no one organization with this responsibility. Instead, there are over fifty banking agencies in the states and territories, the FDIC, the OCC, and the Board, not to mention the National Credit Union Administration and the Federal Housing Finance Agency (formerly the Federal Home Loan Bank Board).

Accordingly, in 1933, Congress assigned responsibility for policing the regulatory perimeter for money and banking to the U.S. Department of Justice (DOJ). The problem with this choice is that the DOJ lacks the expertise and incentives to effectively carry out this duty on its own. To our knowledge, the DOJ has never wielded Section 21(a) to prevent financial firms from issuing functional equivalents to deposits.[17] In the one instance where the DOJ considered a functional deposit equivalent, money market mutual funds, it engaged in a formalistic analysis,[18] contrary to the approach taken by leading banking specialists.[19] Moreover, the statute does not explicitly permit civil enforcement actions, including civil remedies and equitable relief, greatly reducing its potential usefulness. Going forward, to avoid further erosion of the banking laws, Congress should revisit the design of federal entry restriction into banking activities.

  1. Using Agency Authorities

Congress also empowered the FSOC to recommend that other regulatory agencies apply new or heightened standards and safeguards for financial activities that, due to their nature, size, and scale, could create or increase the risk of significant liquidity, credit, or other problems in the financial system.[20] The FSOC should use this power to work with relevant agencies, including its members, to use their authorities to contain risks to investors and consumers posed by stablecoins and their issuers. Among the agencies with significant ability to act are the Fed, SEC, the CFTC, and the CFPB.[21] Where appropriate, these agencies have the power to regulate stablecoins as securities, commodities, derivatives, and financial products.

Most importantly, the SEC has the authority to impose investor protection and related regulatory requirements on any stablecoins that offer investor returns.[22] The SEC also has the authority to regulate stablecoin issuers that qualify as investment companies under the Investment Company Act of 1940.[23] The CFTC has, among other relevant authorities, the authority to address fraud involving stablecoin transactions in so far as stablecoins qualify as commodities under the Commodity Exchange Act.[24] And the CFPB is responsible for enforcing consumer protection laws in connection with transactions for consumer financial products or services, including the prohibition against unfair, deceptive, or abusive acts or practices.[25]

  1. Conclusion

Unregulated and underregulated stablecoins present a clear threat to U.S. financial stability. Even as policy makers seek revisions to the statutory scheme for money and banking to address this threat, the FSOC must act swiftly to use its existing authorities, and the authorities of its member agencies, to mitigate these threats as best as possible.

Respectfully submitted,

Simon Johnson and Erkki Liikanen

on behalf of the Systemic Risk Council


[1] Stablecoins, or stable value coins, are digital ledger entries designed to maintain a stable value in terms of an official currency like the U.S. dollar. Many stablecoins are used as a means of payment. Although based on novel technology, and often operated by new business entities, stablecoins are one of many types of private money claims currently in circulation.

[2] President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation & the Office of the Comptroller of the Currency, Report on Stablecoins (2021).

[3] Stablecoins are a type of “nondeposit deposit” similar to repurchase agreements, eurodollars, money market mutual funds, financial and asset-backed commercial paper, and liabilities maintained by state-chartered money services businesses. See Jonathan R. Macey & Geoffrey P. Miller, Nondeposit Deposits and the Future of Bank Regulation, 91 Mich. L. Rev. 237 (1992). For a discussion of the risks posed by certain money services businesses and how Congress might address them, see Dan Awrey, Bad Money, 106 Cornell L. Rev. 1 (2020); James J. McAndrews & Lev Menand, Shadow Digital Money (2020).

[4] Total Stablecoin Supply, The Block (November 27, 2021), www.theblockcrypto.com/data/decentralized-finance/stablecoins/total-stablecoin-supply-daily.

[5] Like the Reserve Primary Fund, a money market mutual fund, Tether Limited maintains a pool of short-term credit assets that fluctuate in value. Unlike the Reserve Primary Fund, and other money market funds, Tether Limited does not issue equity shares in this pool of assets. It issues a type of general unsecured claim it calls a stablecoin. As of January 31, Tether had issued over $78 billion in stablecoins and purports to have a pool of assets of equal value. When the net asset value of the Reserve Primary Fund fell below $1 on September 16, 2008, it held assets of $62.4 billion. Financial Crisis Inquiry Commission, Final Report 356 (2011).

[6] In fact, in our view, current law requires that the FSOC marshal these tools and carry out the goals of the existing statutory regime.

[7] FSOC may establish special committees “as may be useful in carrying out the functions of the Council.” 12 U.S.C. § 5321(d).

[8] Id. at § 5463(a)(1).

[9] Id. at § 5464.

[10] Id. at § 5463(a)(1).

[11] See, e.g., Neha Narula, The Technology Underlying Stablecoins (September 23, 2021), https://nehanarula.org/2021/09/23/stablecoins.html (describing operational risks stemming from stablecoin technology).

[12] Commercial paper is a type of debt instrument with a short maturity.

[13] We saw something like this in 2008 with money market mutual funds—investment companies that also issue instruments that are redeemable daily, designed to maintain a net asset value of $1, and invest in risky assets like commercial paper. Financial Crisis Inquiry Commission, Final Report 356–60 (2011). FSOC has a further designation authority (under Title I of the Dodd-Frank Act) that would permit it to “require supervision by the [Board] for nonbank financial companies that may pose risks to the financial stability of the United States in the event of their material financial distress or because of their activities.” Id. at § 5332(a)(2). FSOC should also use this authority to address stablecoin issuers as appropriate.

[14] For an overview, see Morgan Ricks, The Money Problem: Rethinking Financial Regulation 102–42 (2016). See also Hugh Rockoff, It Is Always the Shadow Banks: The Regulatory Status of the Banks that Failed and Ignited America’s Greatest Financial Panics, in Coping with Financial Crises (Rockoff & Suto, eds. 2018).

[15] We do not believe that the law imposes a cost-benefit requirement on the FSOC. However, even if it did, see MetLife Inc. v. Financial Stability Oversight Council, 177 F.Supp.3d 219 (2016), the benefits to avoiding monetary system breakdowns, which are driven by fractional reserve arrangements like those maintained by some stablecoin issuers, far exceed any costs entailed by designation, see, e.g., Tyler Atkinson et al., How Bad Was It? The Costs and Consequences of the 2007-09 Financial Crisis, 20 Fed. Res. Bank of Dallas Staff Papers 1, 2 (2013) (estimating the cost at $6 to $14 trillion); Andrew Haldane, The $100 Billion Question, Remarks at the Institute of Regulation and Risk Conference, Hong Kong (Mar. 30, 2010) (suggesting that the present value of the 2008 crisis may have been between $60 trillion and $200 trillion for the global economy as a whole, with 1-5 times annual GDP lost in the US alone); Ben S. Bernanke, The Real Effects of the Financial Crisis, Brookings Papers on Economic Activity (Sept. 13-14, 2018) (finding that the unusual severity of the Great Recession was due primarily to the panic in funding markets, which disrupted the supply of credit).

[16] Congress exempted from this restriction a variety of incorporated and unincorporated banks and state regulated businesses. 12 U.S.C. § 378 (these include company banks, state and federally chartered banks, and state authorized businesses that are subject to examination and regulation in the same manner as banks).

[17] The DOJ has limited its enforcement of Section 21(a) to cases involving other criminal wrongdoing. See, e.g., United States v. Jenkins, 943 F.2d 167 (2d Cir. 1991) (money laundering prosecution).

[18] See Letter from Assistant Attorney General Philip Heymann, Criminal Division, to Martin Lybecker, Associated Director, SEC Division of Marketing Management (Dec. 18, 1979).

[19] See, e.g., Testimony of Paul A. Volcker, Chairman, Board of Governors of the Federal Reserve System, Federal Reserve Membership, Hearings Before the Committee on Banking, Housing and Urban Affairs, 96th Cong., 1st Sess., at 24-26 (Sept. 26, 1979) (raising concerns about allowing financial firms to create functional deposits like MMFs). See also John A. Adams, Money Market Mutual Funds: Has Glass-Steagall Been Cracked?, 99 Banking L.J. 4 (1982).

[20] 12 U.S.C. § 5330(a).

[21] In addition, to the extent that the OCC, FDIC, or state banking authorities are reviewing applications by stablecoin issuers for bank charters (or deposit insurance), the FSOC should also work with these agencies to ensure that the relevant enterprises are fully reserved with respect to their stablecoin holdings.

[22] Stablecoins that offer interest or other returns to stablecoin holders are “securities” under Section 2(a)(1) of the Securities Act of 1933, 15 U.S.C. § 77b(a)(1), as well as Section 3(a)(10) of the Securities Exchange Act of 1934, id. at § 77c(a)(10). This is because such stablecoins are likely “notes” within the meaning of those sections (and notes are securities). See Reves v. Ernst & Young, 494 U.S. 56, 66–67 (1990). They are also likely “investment contracts” (and investment contracts are securities). See SEC v. Howey, 328 U.S. 293, 299 (1946) (holding that an investment contract includes any investment of money in a common enterprise with the expectation of profits solely from the efforts of others). The securities laws apply even if stablecoins are also deposits, provided they are not issued by insured depository institutions. See Marine Bank v. Weaver, 455 U.S. 551 (1982). Stablecoins that do not offer investor returns may not qualify as securities under existing law.

[23] This includes any company that is engaged primarily in the business of investing in securities or is engaged in the business of owning or holding securities and owns or proposes to acquire investment securities having a value exceeding 40 percent of the value of their total assets (exclusive of Government securities and cash items) on an unconsolidated basis. 15 U.S.C. § 80a-3(a)(1). The law excludes Government securities from the definition of securities. Id. at § 80a-3(a)(2).

[24] See 7 U.S.C. § 9(1) (making it unlawful for a person “directly or indirectly, to use or employ, or attempt to use or employ, in connection with . . . a contract of sale of any commodity in interstate commerce . . . any manipulative or deceptive device or contrivance, in contravention of such rules and regulations as the Commission shall promulgate . . .”); see also CFTC v. McDonnell, 287 F.Supp.3d 213 (E.D.N.Y. 2018) (concluding that virtual currencies are “commodities” within the meaning of 7 U.S.C. § 9(1)).

[25] See 12 U.S.C. § 5531.

CFA INSTITUTE SYSTEMIC RISK COUNCIL ANNOUNCES REORGANIZATION

On September 16, 2021, CFA Institute announced that it will be reorganizing the Systemic Risk Council initiative that it established in 2013. 

The Council has been reorganized to feature two co-chairs — Simon Johnson as Council Co-Chair (U.S.) and Erkki Liikanen, Council Co-Chair (Euro area) – to cover the two primary regions of activity.  The SRC will continue to operate as a private sector working group dedicated to serving as the independent, non-commercial voice for proper systemic risk oversight and regulation of markets. “We are excited and honored to carry on the Council’s work and to emphasize our commitment to a clear, trusted and independent voice on needed systemic oversight.  This is particularly true as issues like the global pandemic, climate change and crypto currency bring new challenges to global economic stability,” noted Johnson and Liikanen.

Simon Johnson is the Kurtz Professor of Entrepreneurship and Professor of Global Economics and Management at the MIT Sloan School of Management. He is  a former member of the Congressional Budget Office’s Panel of Economic Advisers and previously served as the International Monetary Fund’s Economic Counsellor (chief economist) in March 2007.  From 2012 to 2019, he was a member of the FDIC’s Systemic Resolution Advisory Committee.  From July 2014 to 2017, Johnson was a member of the Financial Research Advisory Committee of the U.S. Treasury’s Office of Financial Research (OFR), within which he chaired the Global Vulnerabilities Working Group.

Erkki Liikanen currently serves as Chairman of the IFRS Foundation Board of Trustees. He was a two-term Governor of the Bank of Finland and served on the Governing Council of the European Central Bank from 2004 to 2018.  Mr. Liikanen has had an extensive career in public service including two terms as a Commissioner of the European Union and service as Finland’s Ambassador to the European Union.  Mr. Liikanen has worked internationally for many years serving as a governor of the International Monetary Fund and in his role as member of the Governing Council of the European Central Bank, he chaired a group of experts set up by the European Commission to consider EU banking sector reforms in the wake of the financial crisis. The group’s recommendations are known as the ‘Liikanen report’. 

Meanwhile , Jean‐Claude Trichet will continue to serve as Senior Adviser to the Systemic Risk Council, a role he has served in since 2017.   Mr. Trichet was President of the European Central Bank, the European Systemic Risk Board and the “Global economy meeting” of Central Bank Governors in Basel until the end of 2011. Previously, he oversaw the French Treasury for six years and was Governor of the Banque de France for ten years.   Mr. Trichet was a member of the G-20 High level independent panel on financing the global commons for Pandemic, set up in January 2021 . He is Honorary board chairperson at Bruegel (Brussels) , Honorary chairman of the Group of Thirty (Washington), European Chairman of the Trilateral Commission .  He is also member of “Institut de France” (Académie des Sciences Morales et Politiques).

In addition, Sheila Bair, the former chair of Federal Deposit Insurance Corporation (FDIC) from 2006 to 2011 and the founding chair of the Systemic Risk Council,  will continue to support the Council in the role of Senior Advisor filling the vacancy created by the passing of Paul Volcker.  Ms. Bair currently serves on several corporate and governing boards, including the first women Chair of Fannie Mae, Deputy Chair at  Bunge Ltd., and as a Trustee of the Economists for Peace and Security organization.  She served as President of Washington College from August 2015 to June 2017.  Ms. Bair previously served as Assistant Secretary for Financial Institutions at the U.S. Department of the Treasury, Senior Vice President for Government Relations of the New York Stock Exchange and as a Commissioner of the Commodity Futures Trading Commission.

 “We are extremely pleased to have these top-level leaders and policy experts leading this initiative going forward,” said  CFA Institute Managing Director Paul Andrews. Andrews, who will also become a member of the Council confirmed that  moving forward the initiative will be renamed the CFA Institute Systemic Risk Council.   “Our intention is to associate the SRC with the CFA Institute more visibly to demonstrate our commitment and sustained financial support of this independent working-group effort,” noted Andrews.  

Outgoing SRC chair, Sir Paul Tucker, former deputy governor of the Bank of England, has been serving as the SRC chair for nearly six years and leaves the Council in a stronger place. “We are exceedingly grateful to Sir Paul Tucker for the leadership he has provided over the past several years, advancing us to this new phase of the Council’s endeavors,” said Paul Andrews.  “It has been an honor to lead such an extraordinarily expert group of members, from both sides of the Atlantic, in highlighting what, a decade after the global crisis, still needs to be done to ensure an adequately resilient financial system,” said Tucker. “With the constituency for stability always weaker than the public interest warrants, it is important for the Council to carry on this vital work.” 

SYSTEMIC RISK COUNCIL RESPONDS TO SECURITIES AND EXCHANGE COMMISSION CONSULTATION ON REFORM OF MONEY FUNDS AND OTHER OPEN-ENDED FUNDS

WASHINGTON, D. C. —– On April 12, 2021, the Systemic Risk Council issued its preliminary response to the Securities and Exchange Commission consultation on the President’s Working Group report on reforming money market and other open-ended funds in the light of the March 2020 turmoil in U.S. short-term financing markets.

The SRC welcomes the PWG report and the SEC’s initiative. After the money market has been bailed out twice in just over a decade, the current review is badly needed. In its response, the Council offers views on, among other details, gates and floating net asset values. More generally, it emphasizes that the underlying problem arises where particular asset classes are widely perceived as safe and liquid even when they are inherently fragile. The problem will not be solved until the authorities, working with Congress, determine what money-like instruments will be backed by Federal Reserve liquidity insurance, the regulatory and other conditions attached to that access, and how to prevent other non-banks getting access to the safety net.

Paul Tucker, chair of SRC, said:

“Shadow banking vulnerabilities are the financial system’s Achilles Heel, but have been neglected for years. Short-term financing markets have been driven by a widespread perception that money funds are safe, making it almost inevitable the federal government provides rescue facilities when trouble hits. Something has to change.”

The full text of the SRC’s letter to the SEC is available here or http://www.systemicriskcouncil.org/wp-content/uploads/2021/04/Systemic-Risk-Council-Comment-Letter-File-No.-S7-01-21.pdf

Systemic Risk Council Urges Congress To Demand Renewed Vigilance In Preserving Stability After US Equity Market Episode

WASHINGTON, D. C. —– On March 3, 2021, the Systemic Risk Council issued a letter to the US Congress on the resilience and stability of the financial system in the wake of the recent extraordinary equity market volatility.

In addition to well publicized questions on market integrity and efficiency raised by the GameStop episode, the Systemic Risk Council urges the Senate Banking Committee and House Financial Services Committee to ensure the following four financial stability-related issues are properly addressed by the administration and the regulatory agencies:

  • Whether the clearing house’s collateral practices were adequate
  • Whether capital requirements for broker dealers are high enough
  • Whether re-hypothecation of collateral should be banned, or constrained
  • Whether the financial authorities could have done more to maintain system-wide resilience as feverish levered trading in capital markets was fueled by sustained monetary measures to support economic recovery

 Paul Tucker, chair of SRC, said:

“While the recent equity market kerfuffle was not a direct threat to stability, the authorities must energetically learn from an ugly episode involving a scramble for collateral, to close out positions, and to cut off services. Congress should ensure the unfinished business of rebuilding the financial system’s resilience resumes.” 

The full text of the letter to Congress is here.

The text of the SRC’s 2020 statement on unfinished business is here: http://4atmuz3ab8k0glu2m35oem99-wpengine.netdna-ssl.com/wp-content/uploads/2020/10/SRC-Reigniting-the-Reform-Debate.pdf.

Systemic Risk Council Urges Congress To Demand Renewed Vigilance In Preserving Stability After US Equity Market Episode

WASHINGTON, D. C. —– On March 3, 2021, the Systemic Risk Council issued a letter to the US Congress on the resilience and stability of the financial system in the wake of the recent extraordinary equity market volatility.

In addition to well publicized questions on market integrity and efficiency raised by the GameStop episode, the Systemic Risk Council urges the Senate Banking Committee and House Financial Services Committee to ensure the following four financial stability-related issues are properly addressed by the administration and the regulatory agencies:

  • Whether the clearing house’s collateral practices were adequate
  • Whether capital requirements for broker dealers are high enough
  • Whether re-hypothecation of collateral should be banned, or constrained
  • Whether the financial authorities could have done more to maintain system-wide resilience as feverish levered trading in capital markets was fueled by sustained monetary measures to support economic recovery

 Paul Tucker, chair of SRC, said:

“While the recent equity market kerfuffle was not a direct threat to stability, the authorities must energetically learn from an ugly episode involving a scramble for collateral, to close out positions, and to cut off services. Congress should ensure the unfinished business of rebuilding the financial system’s resilience resumes.” 

The full text of the SRC’s letter to Congress is available here:

The text of the SRC’s 2020 statement on unfinished business is here: http://4atmuz3ab8k0glu2m35oem99-wpengine.netdna-ssl.com/wp-content/uploads/2020/10/SRC-Reigniting-the-Reform-Debate.pdf.