S. Hrg. 113-393
THE ANNUAL REPORT AND OVERSIGHT OF THE OFFICE OF FINANCIAL RESEARCH
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
ECONOMIC POLICY
OF THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
ON
REVIEWING THE OFFICE OF FINANCIAL RESEARCH'S ANNUAL REPORT, DISCUSSING
OFR'S EFFORTS, ACTIVITIES, OBJECTIVES, AND PLANS, AND CONTINUING ITS
OVERSIGHT OF THE IMPLEMENTATION OF THE DODD-FRANK WALL STREET REFORM
AND CONSUMER PROTECTION ACT
__________
JANUARY 29, 2014
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon MARK KIRK, Illinois
KAY HAGAN, North Carolina JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota
Charles Yi, Staff Director
Gregg Richard, Republican Staff Director
Dawn Ratliff, Chief Clerk
Taylor Reed, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
______
Subcommittee on Economic Policy
JEFF MERKLEY, Oregon, Chairman
DEAN HELLER, Nevada, Ranking Republican Member
JOHN TESTER, Montana TOM COBURN, Oklahoma
MARK R. WARNER, Virginia DAVID VITTER, Louisiana
KAY HAGAN, North Carolina MIKE JOHANNS, Nebraska
JOE MANCHIN III, West Virginia MIKE CRAPO, Idaho
HEIDI HEITKAMP, North Dakota
Andrew Green, Subcommittee Staff Director
Scott Riplinger, Republican Subcommittee Staff Director
(ii)
C O N T E N T S
----------
WEDNESDAY, JANUARY 29, 2014
Page
Opening statement of Chairman Merkley............................ 1
Opening statements, comments, or prepared statements of:
Senator Heller............................................... 2
WITNESSES
Richard Berner, Director, Office of Financial Research,
Department of the Treasury..................................... 3
Prepared statement........................................... 17
Responses to written questions of:
Senator Brown............................................ 23
(iii)
THE ANNUAL REPORT AND OVERSIGHT OF THE OFFICE OF FINANCIAL RESEARCH
----------
WEDNESDAY, JANUARY 29, 2014
U.S. Senate,
Subcommittee on Economic Policy,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 3:30 p.m., in room 538, Dirksen
Senate Office Building, Hon. Jeff Merkley, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF CHAIRMAN JEFF MERKLEY
Chairman Merkley. Good afternoon. I call this hearing to
order of the Economic Policy Subcommittee of the Senate
Committee on Banking, Housing, and Urban Affairs.
I have a short opening statement. I believe that Senator
Heller may be joining us in a moment. He may have a short
statement, as well. And then we will turn directly to Dr.
Berner's testimony. We are so pleased to have you with us
today.
Mr. Berner. Happy to be here.
Chairman Merkley. A healthy, safe financial system is vital
to a robust economy that works for middle-class America. From
deposits to small business loans, retirement advice to loan
insurance, to a home mortgage, to an auto loan for working
families and the Main Street economy rely every day on the
financial system to help them build a healthy financial
foundation. This system is critical to a growing economy, as it
also helps channel capital to new opportunities.
But as we all remember from Jimmy Stewart and ``It's a
Wonderful Life'', and more recently from our own experience in
2008, the financial system can also be quite fragile. When
firms have too little capital, too little oversight, or weak
interconnections and volatile markets, in other words, when
systemic risks go unaddressed, the result is often a banking
crisis that can culminate in a great recession or a great
depression. Ordinary families lose jobs, homes, savings, and
businesses as lender and investor confidence dries up. There is
no accident. It takes much longer to return to full employment
after a financial crisis than after a simple recession.
In the years since the 2008 crash, we have put in place a
series of important reforms. We established a dedicated
Consumer Protection Agency. We mandated clearing and
transparent trading of derivatives. We separated hedge fund-
like betting from the loan-making banking system. We required
higher capital in our banks. And we created the ability to wind
down a failed financial company. Dodd-Frank has sought to
restore protections and oversight to make our system work
better for the middle class and to prevent future crises.
Have we done enough? There is undoubtedly more to do and we
should not stop grappling with that question.
One clear lesson from the 2008 financial crisis was that
neither the private sector nor the public regulatory agencies
could adequately identify the risks they faced. In the future,
we must do a much better job of identifying and addressing the
systemic risks before it is too late.
That is why Dodd-Frank created the Office of Financial
Research. As its Congressional authors envisioned it, OFR is
supposed to be a kind of National Institute of Finance, to cure
gaps in data and analysis, to engage in and support cutting-
edge research, and to look through the complexity of our
financial system and provide Congress and the public with
independent and transparent assessment of what risks we face
and what can be done about it.
The mission set out for OFR is no small task, and it is
important that OFR and others get it right, from understanding
asset managers to monitoring repo and more. The Annual Report
that we will hear about today is only the beginning of OFR's
efforts to live up to that mission.
This is the first appearance of Dr. Berner, or any OFR
Director, before the Senate Banking Committee. I thank Dr.
Berner for being here today and to further discuss OFR's work
over the last year and the contents of its Second Annual
Report. It is tremendous to have you, and we will now turn to
Senator Heller, if you have an opening statement.
STATEMENT OF SENATOR DEAN HELLER
Senator Heller. I do. Thank you, Mr. Chairman, and thanks
for holding this hearing today, and thank you, also, to Dr.
Berner for being here and giving our Subcommittee an overview.
Created by Dodd-Frank, the OFR serves the Financial
Stability Oversight Council with the stated goals of improving
the quality, transparency, and accessibility of financial data
and information. I think it is worth reminding everyone that
this Government organization does not receive Congressional
appropriations and lacks standard accountability to Members of
Congress, and most importantly, to the American public. Much
like the Consumer Financial Protection Bureau, the OFR has the
authority to collect unprecedented amounts of data from
businesses.
While there are many concerns about this organization, I
will focus most of my attention today on OFR's September report
on asset management and financial stability. In this report,
the OFR alleges that asset managers could pose risks to the
broader financial system. Since the report was released, there
have been serious allegations that OFR's conclusions were
unsupported by inadequate data, used one-size-fits-all
modeling, and neglected to consider current regulatory
frameworks.
While there are certainly individuals who would like to
argue whether one company or another should be labeled as
systemically important, I think everyone should agree that
those decisions should be made after evidence-based facts have
been found through comprehensive evaluations.
After a few years, both Republicans and Democrats have
expressed concerns with OFR's actions, and even the Government
Accountability Office has questioned OFR's standards. It is my
hope today that Dr. Berner will provide some clarity and
transparency about OFR's recent work and decisions.
So, again, Mr. Chairman, thank you and I look forward to
hearing Dr. Berner's testimony.
Chairman Merkley. Thank you very much for your opening
statement. The record will remain open for 7 days for
additional statements or for questions for the record.
Would the Senator from Massachusetts like to make an
opening statement?
Senator Warren. No, Mr. Chairman. I am ready to get right
to the testimony and the questions. Thank you.
Chairman Merkley. Thank you.
I would now like to introduce Dr. Richard Berner, our
witness. Dr. Berner has served as the first Director of the
Office of Financial Research since January of 2013. Prior to
his confirmation as Director, he served as counselor to the
Secretary of the Treasury with responsibility for standing up
the OFR.
Before joining the Treasury in April 2011, he was cohead of
Global Economics at Morgan Stanley. Dr. Berner previously
served as Chief Economist at Mellon Bank, and before that, he
worked as a Senior Economist at Morgan Stanley, Salomon
Brothers, Morgan Guaranteed Trust Company. For 7 years, he
worked on the research staff of the Federal Reserve Board in
Washington. He has also been an Adjunct Professor of Economics
at Carnegie Mellon University and George Washington University.
More follows. Dr. Berner has been a member of the Economic
Advisory Panel of the Federal Reserve Bank of New York, the
Panel of Economic Advisors of the Congressional Budget Office,
the Executive Committee and the Board of Directors of the
National Bureau of Economic Research, and Advisory Committee of
the Bureau of Economic Analysis.
Dr. Berner has won forecasting awards from Blue Chip
Economic Indicators, the Wall Street Journal, Market News, and
the National Association for Business Economics. He received
his Bachelor's degree from Harvard College and his Ph.D. from
the University of Pennsylvania.
Dr. Berner, welcome, and please begin.
STATEMENT OF RICHARD BERNER, DIRECTOR, OFFICE OF FINANCIAL
RESEARCH, DEPARTMENT OF THE TREASURY
Mr. Berner. Chairman Merkley, Ranking Member Heller, and
Members of the Subcommittee, thank you very much for your kind
introduction and the opportunity to testify today about our
2013 Annual Report and oversight of the Office.
Chairman Merkley, as you noted, this is my first Senate
hearing as OFR Director, so let me take this opportunity to
state my commitment to make the OFR a valued resource for the
Congress, the Financial Stability Oversight Council, and the
American people. This report and my testimony are two of many
ways that we can inform the Congress and other stakeholders
about our work. We are committed to being transparent and
accountable, so I look forward to further opportunities to
discuss with you our efforts to help promote financial
stability.
My written testimony covers in detail the topics in your
invitation letter, so I just want to highlight a few of those
topics now.
First, our report documents how we are doing our job. We
focus on potential threats to financial stability and the tools
and data we are developing to assess and monitor them. In the
report, we unveil a new tool, our Financial Stability Monitor,
to identify and monitor such threats. By tracking five areas of
risk and spotting vulnerabilities across the financial system,
we aim to pinpoint causes of instability rather than just
symptoms. The monitor is a prototype. We are already working to
improve it. For example, we plan to develop more forward-
looking indicators to help us see not only where we are, but
also where we are going.
In the report, we identify eight potential threats to
financial stability. One of those threats, instability in
emerging markets, has affected U.S. financial markets in the
last 2 weeks. Recent sharp declines in some emerging markets,
economies, currency and asset markets, spilled over quickly
into U.S. markets for risky assets, such as stocks. In
coordination with Council member agencies, we are monitoring
these developments carefully.
We are mandated to fill key gaps in financial data and to
implement data standards. The report outlines several OFR
projects to improve the scope and quality of financial data.
For example, we are working with the Federal Reserve Bank of
New York to improve and expand data to measure activity in
short-term funding markets. Data standards are critical to
improve financial data quality, and we devote a whole chapter
in the report to them.
One key example is the Legal Identity Identifier. LEIs are
like bar codes for uniquely identifying entities involved in
financial transactions. They benefit industry by helping to
lower reporting costs. They benefit regulators with better data
for policy decisions. And they benefit researchers with
consistent data for analysis. The Office has provided global
leadership for the LEI system. We lead the U.S. regulatory
delegation, and our Chief Counsel serves as Chair of the LEI's
Regulatory Oversight Committee. To be truly useful, the LEI and
other data standards must be universally adopted, so I have
called on regulators in the U.S. and globally to require use of
the LEI through regulatory rulemaking.
Another data standard that is important to establish is a
single cradle to grave standard for mortgage data called the
Universal Mortgage Identifier. Our Annual Report and our latest
working paper describe this proposal in detail. This
standardization effort is a good example of how we coordinate
with other agencies. In addition, publishing the proposal in
our working paper series and our Annual Report illustrates two
of the several ways we make our analysis and studies available
to the public.
The work I have just described is a fraction of what we
have done and we plan to tackle much more in 2014. We no longer
talk about standing up the OFR as an institution. The OFR is
not only standing on its own, but is making important
contributions to help promote U.S. financial stability.
Hearings like this one are vital forums for you and the
American people to receive timely and accurate information
about our work and our plans. I look forward to further
engagement.
Thank you again for the opportunity to appear today. I
would be happy to respond to your questions.
Chairman Merkley. Thank you very much, Doctor, and I think
we will have 5 minutes on the clock for each Senator and I will
begin the questioning with this observation.
If this was 2007, we might be expecting you to put up a
chart showing the dramatic replacement of prime mortgages with
subprimes. You might be talking to us about collateralized debt
obligations and CDO-squared. You might be commenting on the
risks imposed by credit default swaps that posed as--apparently
created an insurance--attempted to create an insurance for
mortgage securities, and whether or not those were actually
backed up in the form that an insurance product needed to be
backed up. You might have identified, also, the challenge with
the rating of credit securities or mortgage securities and the
model in which folks essentially find out what their rating is
before they choose who will do the rating. You might have
mentioned a whole bunch of things that were central to the
meltdown that occurred in 2008.
As you sit here today, if you were kind of recreating in
this moment the key factors that we should consider to prevent
a meltdown in 2016, 2 years from now, what would be the top
three factors you would identify?
Mr. Berner. Well, Senator, that is a great question, not an
easy one to answer. Let me state first that when we think about
the financial system, it is very hard to predict financial
crises. In fact, I am not sure that we really can predict
crises. We can identify, however, vulnerabilities, and it is
those key vulnerabilities that we look to to see where the weak
points are in the financial system that might be exposed by
shocks to the system.
So, as I think about the top three vulnerabilities that are
out there right now, we have identified some of them in our
annual report. One relates to the potential for the markets to
be exposed to an abrupt and sharp rise in interest rates or in
volatility. That is because while interest rates have risen
somewhat, portfolios are still oriented toward the notion that
interest rates would stay quite low, so a rise in rates could
be disruptive. A rise in volatility in financial markets,
likewise, could be disruptive, because that would change asset
prices and have a profound impact on markets. So, those two
related factors would be the first vulnerability that I would
look to.
The second vulnerability that I think has been mentioned
many times before by others are the continuing issues
surrounding short-term wholesale funding and securities
financing transactions. Those are markets that are extremely
important for the functioning of our financial system. They are
markets that do not have the advantage that bank deposits have.
They do not have a backstop from the lender of last resort.
Deposit insurance does not cover them. And there are lots of
proposals out there to make those markets stronger and more
stable, although we have not yet implemented them and there is
still risk in those markets and in related transactions.
Chairman Merkley. You are referring to the repo markets?
Mr. Berner. I am referring to repo markets, yes.
Chairman Merkley. Repo, yes.
Mr. Berner. Repo, among others, and related activities such
as what is called the reinvestment of cash collateral in
securities lending transactions. So those are all--that is a
group of problems that we might focus on.
The last of the top three might be the one I referred to
before, and that is we live in a global, interconnected world.
Markets are global. Institutions are global. Shocks that
emanate from abroad, vulnerabilities that exist abroad, can
spill over back to our markets and our economy. I think we need
to be aware of those. I think the emerging market situation
today, while it does not seem to be, at the moment, one that
could spill over in the ways that it perhaps has in the past,
it is something that we need to monitor pretty carefully, and
it is that monitoring and assessment of where the potential
risks might lie that really animates our work.
Chairman Merkley. In the 40 seconds I have left, I was
surprised to see that you had the spillovers from emerging
markets, but not spillovers from the European markets. Any
quick insight on that?
Mr. Berner. I do. That is still an issue. The European
economy is still troubled by slow or no growth. Their banking
system still has many problems that are widely known. So, you
cannot rule out that there would be problems that emanate from
that source, as well.
Chairman Merkley. Thank you.
Senator Heller.
Senator Heller. Thank you.
Doctor, thanks again for being here. Your asset management
report states that it was conducted to better inform FSOC as to
whether or how to consider asset management firms, their
designation as SIFI institutions, systemically important
financial institutions. Do you believe that the OFR study
should be solely relied on as FSOCs move forward with
considering asset managers as systemically important?
Mr. Berner. Senator, the report was put out to inform the
consideration of the Council and it is only one ingredient in
the Council's deliberations. I obviously cannot speak for the
Council. I am a member of the Council, but a nonvoting member,
so I cannot speak for the Council or its other members. But I
want to draw a sharp distinction between the work that we do in
support of the Council and the Council itself. The Council will
decide on what to do with assessing truly whether there are
threats in the activities of asset managers and what, if any,
remedies ought to be taken in response to those threats. And
our report was designed to inform the Council and to provide
them with information. The work of the Council is ongoing and
we continue to support the Council with data and analysis in
that regard.
Senator Heller. Also, your asset management report, you
mentioned that OFR was looking for activities rather than
particular firms. Some argue that the size of the asset manager
alone would not or should not indicate whether it was a source
of greater risk. Would it then be appropriate that the SEC
should be looking into whether certain activities deserve
tighter oversight rather than simply selecting larger asset
managers and putting them under heightened supervision through
SIFI designation?
Mr. Berner. Well, Senator, I definitely agree with the
notion that the analytical focus that should be used in looking
at asset management activities is the activity. That captures
where the activity is being undertaken, whether it is in an
asset manager or its counterparties, its clients, and its
intermediaries. And so I think that is a better way to look at
the potential problems. I cannot prescribe what other
regulators should do, but I think that is the way to look at
it.
Senator Heller. Has there been a designation of a SIFI, any
SIFI designations up to this point?
Mr. Berner. Senator, there have been designations of a
captive finance company and two insurance companies----
Senator Heller. OK.
Mr. Berner. ----and the process continues.
Senator Heller. In that report, it also stated that
significant data gaps impeded effective macroprudential
analysis and oversight of asset management firms and
activities. The question is, is it responsible as a researcher
to publish any conclusions in a report without complete and
appropriate data to back those conclusions?
Mr. Berner. Well, Senator, I think it is responsible to put
the information out there. We clearly indicated that our
estimates of a variety of metrics relating to the asset
management industry were just that, estimates. Because there
are data gaps, we would like very much to focus on some of the
areas for which we do not have adequate data and to fill those
gaps so that we can do more work on looking at the industry.
Those include separately managed accounts for which we have
only scarce data, as well as more detailed data on securities
lending transactions, which, as I mentioned earlier, could be
the source of a potential problem.
Senator Heller. Did you ever ask asset managers directly to
provide data of their asset management report?
Mr. Berner. We have not directly asked asset managers to
provide any data. We did, however, engage with--vigorously with
ten asset managers and the industry and trade groups
continually to discuss their business model, their business
mix, how they manage their risk, other factors relating to the
very detailed nature of their business. So, we have had a lot
of discussions with the industry itself.
Senator Heller. Did OFR ever work with the SEC on this
report before issuing a final product?
Mr. Berner. Yes, we did. We engaged with the SEC almost
from the start, because they are the primary regulator for most
of these companies and they have the expertise, long acquired,
to look at these companies. So, we wanted to make sure that we
were on the same page, both with respect to the existing
regulation, the nature of the businesses, and where the
problems might arose. And so on all three accounts, we did
engage aggressively for more than a year with the SEC and had,
I cannot tell you how many phone calls, et cetera, meetings
with them, to talk about this report.
Senator Heller. Doctor, thank you. Mr. Chairman.
Chairman Merkley. Senator Warren.
Senator Warren. Thank you, Mr. Chairman, Ranking Member,
for holding this hearing. Thank you for being here, Dr. Berner.
So, the OFR obviously plays a very important part in our
regulatory system. In essence, your job is to look at the data
and the gaps in the data and identify possible sources of risk
in the financial system--no politics, just an independent
analysis of what is going on. I think it is a really important
role.
And that is exactly what OFR did in its recent report on
asset managers. You reviewed the available data, you identified
serious gaps in the data, and you raised some issues that
prompted a robust and healthy debate about the role that asset
managers play in the financial system. So, I want to say, thank
you, Dr. Berner, for the work you and your staff put into that
report. I think that is very important.
Mr. Berner. Thank you.
Senator Warren. So, what I want to focus on, though, is the
importance of collecting the necessary data, because you
identify data gaps in this report. So, I imagine that the
agencies that oversee the financial system, the SEC, the OCC,
the Fed, the FDIC, have all sorts of data that the OFR would
find helpful in its research, and yet as I read Dodd-Frank,
those agencies are not required to share the data with OFR. So,
what I want to ask about is whether OFR has been able to obtain
all of the data it needs from these agencies.
Mr. Berner. Thanks for your question. The answer to your
question is, so far, yes, but I want to emphasize the fact that
the engagement with our colleagues elsewhere on the Council is
one that requires some thought and some care, and that is
because many of the data sets that we look at that they collect
are nonpublic data and they have confidential information in
them.
Senator Warren. I understand.
Mr. Berner. As a consequence, they want to be assured that
the data that they share with us are kept as secure as they
would keep them, and so we have worked out a process to exactly
do that, a variety of processes to make sure there is an
agreement, a memorandum of understanding between us for each
characteristic of each particular data set, and sometimes that
takes time to work out. The more specific we can be in our
request, the more finely we can tailor those agreements to
reflect the nature of the data.
We are working hard on data sharing, which is something
that we think is necessary for the Council, not just for us, to
do its job. We have made several proposals on how to make that
easier. The Council of Inspectors General for Financial
Oversight has made several proposals on that and we are working
hard in the context of the Council to make sure that the
Council embraces and adopts those proposals so that we can
better share data, on one hand, while keeping them confidential
on another.
But, we have obtained data in several different areas and
we are using those very detailed nonpublic data to analyze
interconnectedness and risks and the transmission of risks
across the financial system.
Senator Warren. Well, good, because I think it is very
important that all of the agencies be sharing data with you. I
am glad you are working on the MOUs to make that possible. And
I hope there are no difficulties in data sharing as we go
forward, because without good data, you cannot give good
independent advice. So, let us know if there are problems
there.
But, I want to ask you one other data question in this, and
that is about your ability to obtain data from financial
companies. I know that you have subpoena power to require
companies to produce data under certain limited circumstances,
but from what I understand, you have never used that power, is
that right?
Mr. Berner. That is true, and we actually have never asked
a financial company in the United States to turn over data to
us because there are many data that are available already, as
you indicated, that are collected by other agencies, that are
publicly available or available in some other form. And so our
philosophy for filling data gaps has three steps. First is to
prioritize and identify the questions we want to answer.
Second, to take stock of the data we have, and we just
published a very recent data inventory on our Web site to do
exactly that. And then matching those two things enables us to
sort of look to where the gaps in data are and to prioritize
them.
Now, there are still lots of gaps in data, as you and I
agree, and what we need to do is to work very carefully to
think about asking the companies for exactly what we need, to
make sure, just as we do with other regulators, that those data
would be kept secure if they are nonpublic data, and
confidential, to assure the companies that their data will not
be in jeopardy, their data will not be compromised, and that is
particularly important in today's environment, where we are all
concerned and trying to take steps to assure that threats,
cybersecurity threats, do not destabilize our financial system.
Senator Warren. Well, I very much appreciate that you are
cautious in your data requests, both from other agencies and
from financial institutions, but at the same time, I hope you
are vigorously pursuing everything that you need and that you
have all of the tools you need to get those data, because
without good data, you will not be able to make good
recommendations. I know you know that and I just want to offer
my support for your ability to get the information that you
need to help advise us all about the risks we face in the
financial system. Thank you.
Mr. Berner. Thank you, Senator. If I need any help, I will
be sure to let you know.
Senator Warren. Good.
Chairman Merkley. Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman, and thank you, Dr.
Berner, for your work and for being here.
Like several others, I have a concern about the possible
push to designate several asset manager firms as systemically
important, and I apologize if you all have discussed this
before I came. And it is interesting, in this specific issue,
in this case, you have some very divergent people and views in
terms of financial services, like Barney Frank and Peter
Wallison both agreeing that they do not think this should be
considered. Barney Frank, in particular said, quote, ``it just
seemed to me a listing of possible horror stories with no
indications that there was any significant likelihood of any of
it happening. Systemic risks occur not only when people lose
money, but when the people who lose money cannot back up their
losses and you get this cascading effect. That would make
everyone in America a systemic risk. I was really disappointed
in that one,'' close quote, talking about, I think, part of
your study. Can you react to that in general and the Peter
Wallison and Barney Frank critique of this possible movement in
this direction?
Mr. Berner. Senator, if I could, I would like to separate
the identification of possible risks and asset management
activities from any remedies that might be taken in response to
those risks. Part of our job is to identify the risks and where
they might lie and to provide the framework of analysis and the
data, as we were just discussing, to identify those risks. The
Council's job is to also work on identifying those risks, but
also to propose and potentially implement any remedies. So, I
am not in the business of proposing remedies. I am in the
business of trying to identify where the risks might lie and--
--
Senator Vitter. Well, first of all, I understand that, but
obviously, the study is a prelude to that decision, so they are
closely related. And, second, it seems to me this critique is
about characterizing the nature of the risk.
Mr. Berner. Well, the study focused on activities, not on
firms, and the study, therefore, analytically could not be used
as the sole basis for any designation process.
Senator Vitter. Yes. I did not say it would be the sole
basis.
Mr. Berner. And, frankly, it could not be really used as
the basis, because to designate a firm, you need to do the
analysis that relates to that firm. We wanted to look at
activities because we fully recognize that asset managers are
basically in the business, and in the agency business, they
manage assets on behalf of their clients, not on behalf of
themselves. It is, as you indicated earlier, it is money that
they--where the client may lose money, but the asset manager
itself may not be threatened by a simple change in market
value.
Those are not the risks that we are concerned about. We are
concerned about other risks that we talk about in the report in
some of the activities in asset managers, where there is
opacity, for example, in separately managed accounts, which we
think are roughly 40 percent of assets under management by U.S.
firms on a global basis. We need to shine a spotlight in those
areas and find out more about what is going on in those
accounts.
Second, we pointed out that when asset managers lend out
their securities in a securities lending transaction, they get
in receipt for the lending of those securities, they get cash
back that they can then reinvest. If there is an abrupt change
in market prices, that investment of the cash collateral, as it
is called, that comes back, could unwind quickly and could have
destabilizing impacts on markets. So, asset managers are
affected by market developments, and if they are sharp changes
in market prices, or a sharp change in perceptions, then their
activities could give rise to potential threats to financial
stability, and we think those are some of the vulnerabilities
that we need to take a closer look at.
We have not arrived at any conclusions, as I said, about
remedies. We are simply looking at potential threats.
Senator Vitter. Related to this, let me also ask you about
process. A lot of the firms involved and others, including
members, have been frustrated and concerned about what they
consider sort of a black box process and very little ability
for folks in the business who know the details of their
business to see elements of an ongoing study and react to it or
critique it in a constructive way at all. I know there is not
any legal requirement for you to have some sort of comment
period, but what is the purpose of not being more interactive
than you are in doing studies with the goal of getting the
study right and understanding as good as possible what the true
facts are and situations are in the real world?
Mr. Berner. Senator, as I indicated earlier, we engaged
with ten large asset managers in considering our study. We sent
teams of experts to visit with those asset managers. I
personally went to visit with five or six of them, or were on
the phone with some of the others. I spent 30 years in the
business, so I have a lot of contacts in the asset management
industry with whom I consulted and we all consulted in putting
the report together.
I think that it is important to recognize that we have a
transparent, open door policy. There is not a single asset
manager, not a single trade group, representatives of asset
managers, who asked to have a meeting with us that we have
turned down. We repeatedly----
Senator Vitter. I do not want to interrupt, but I think if
you talk to them and ask them, they will say, yes, we had a
meeting and we got no reaction from anyone about what the
thinking was or where this might be headed and no real ability
to react to that. And so that is what they thought was
completely lacking.
Mr. Berner. Senator, all I can say is that I found those
meetings very constructive. There was a vigorous give and take
at those meetings about--and a lot of questions about the
things that we might be concerned about, some of which I
mentioned earlier. So, I cannot speak for them. All I can do is
say that those discussions were vigorous. We continue to
welcome engagement with the industry. We continue to welcome
opportunities to talk to the industry. And we continue to
welcome the opportunity to do more work in this area.
Senator Vitter. Well, I would just ask you to think about
that process----
Mr. Berner. OK.
Senator Vitter. ----because there is real frustration about
that process from their point of view, about hearing where
might be headed or what your sort of draft thoughts are and
having an opportunity to react to that rather than just be able
to make a presentation to sort of a stone-faced representative,
and I think that is an accurate description of most of their
reaction. It took the SEC, for instance, to put the study out
to comment in any way, so that certainly was not formally done
by you all. But thank you.
Chairman Merkley. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman, and I appreciate
your indulgence in allowing me to attend, since I am not on the
Subcommittee, but I am on the full Committee, and I appreciate
your having this hearing.
Dr. Berner, thank you very much for being here. I kind of
want to go down a similar road that Senator Vitter went down,
and I share his concern that I think you could argue that the
September report in some ways may overstate the risks and in
some ways minimizes the very extensive regulation that is
already in place on asset managers. And our concern--some of us
are concerned that if that is the impression that the report
creates, it might increase the chances of a SIFI designation,
which I think would be a big mistake, and I understand that is
not your call, and I am not suggesting that that was your
intent, but it could be the consequence.
And so one of the things that strikes me is that the report
does not spend much emphasis on the very extensive regulation
that is already in place, has been in place on asset managers
for a very long time. As you know, they are regulated by the
SEC, the CFTC, the DOL, the Treasury Department, as well as
international regulators. Senator Vitter pointed out quite
rightly that even Congressman Barney Frank suggested that Dodd-
Frank was never intended to result in asset managers being
designated as SIFIs.
And so in light of the extensive, and, I would argue, very
effective regulation that this industry has been subject to for
a very long time and continues to be subject to, I guess, could
you reflect on how additional either prudential regulation or a
SIFI designation, how would that diminish systemic risk
throughout the system?
Mr. Berner. Senator, as I mentioned earlier and as you
indicated, the actual remedies for any threats to financial
stability are not in my bailiwick. But, I think the basic--I
would like to make a couple of points.
One is that when we engaged with the SEC, one of the
reasons that we engage so extensively and over a long period of
time with the SEC was to make sure that we got the description
as well as the effect on the industry of the regulations that
exist. And there are, as you well know, two basic parts to the
industry. The '40 Act funds that are regulated extensively and
comprehensively by the SEC are not our primary concern,
although there are some issues potentially that might exist in
the activities of asset managers that relate to those funds.
It is in other areas and other activities that we see
potential problems and potential vulnerabilities. And so that
is why I keep emphasizing the basic fact that it is those
activities that I think are important to focus on. It is those
activities where we have to do more work, more analysis. It is
those activities where--for which we lack adequate data right
now to do the analysis and for which we intend to collect on an
appropriate basis and in an appropriate way additional data so
that we can do the work on those activities.
Senator Toomey. So, systemic risk by its very nature is a
risk that is transmittable throughout the system, throughout
institutions. Otherwise, it is not systemic, right. Could you
just give us some thoughts about what are the transmission
mechanisms you are concerned about with respect to asset
managers.
Mr. Berner. Well, again, focusing on asset management
activities, one of the things that concerns us is that if an
asset manager is hit by an external shock, even if it is not
the source of that shock, it could transmit or amplify to the
rest of the financial system through its activities that shock.
Senator Toomey. How would it transmit them?
Mr. Berner. It would transmit them through potentially what
are called fire sale, if the asset manager in question--a fire
sale is a sale of assets at prices well below their indicative
value----
Senator Toomey. Right, but just to explore that a little
bit, right----
Mr. Berner. Mm-hmm.
Senator Toomey. If there were a specific problem with a
specific manager that caused the investors to decide they
wanted to withdraw their money, is it not quite likely they
would just put their money with a different manager, because
they want to be invested in the markets under this scenario.
They have just got a concern with this particular manager.
Mr. Berner. Right. And that is why, Senator, I am talking
about activities. So, if a lot of asset managers are doing
similar things, and these problems affect more than one asset
manager, they affect the activities of a particular asset
manager rather than a specific firm, that is the circumstance
where we think there might be potential threats. So, it is not
about the firms as we characterize it and as we do our
analysis. It is about the activities in which those firms
engage, and those are the things that we need to keep in mind.
Senator Toomey. And those activities are regulated now by
the SEC and other--principally, but other regulators, as well,
right?
Mr. Berner. Well, the regulation of--they are all
regulated, for example, by the Department of Labor, by ERISA,
as Senator Merkley and Senator Heller indicated, but the
regulation of, for example, activities in separately managed
accounts is quite different from the regulation that oversees
so-called '40 Act accounts.
So, let me give you an example. In '40 Act accounts, there
is a restriction on the extent to which you can lend out for
securities lending purposes the portfolio that you are
managing. It is limited to roughly a third. In separately
managed accounts, however, there is no such limitation. You can
lend out the entire portfolio.
So, a firm that engages in securities lending activity may
choose to lend out the entire portfolio from its separately
managed accounts, but that is something that we are not quite
sure of, where there is a lot of opacity around, and if you are
lending out the whole portfolio and the circumstances arise
that would create the unwind that I was talking about, then
that is something that we should know more about. It is
something that we should try to monitor and to try to assess
where the risks are.
Senator Toomey. Thanks very much. Thank you, Mr. Chairman.
Chairman Merkley. Thank you very much, and I think folks
are interested in another round of questions.
I wanted to start with the two issues that you identified
as number one and number two, a potential sharp rise in
interest rates and then the repo markets and the potential
contagion effect that can occur between firms. In regard to a
potential sharp rise in interest rates, of course, up here on
Capitol Hill, we hear the words ``sharp rise in interest
rates'' and we are thinking in the context of U.S. Treasury
bonds and what that means to our budget. But that may not be
exactly what you are concerned about here, so paint out a
couple scenarios that lead to the sharp rise in interest rates
and where those interest rate rises occur, and then how those
reverberate through the economy in ways we should be concerned
about.
Mr. Berner. Well, Senator, it is a good question. The rise
in rates that could be destabilizing, it is hard to calibrate
exactly what we mean by sharp, or hard to characterize what we
mean by abrupt. But right now, the fact is that we live in a
relatively moderate growth, low inflation environment and
investors have embraced that and they positioned their
portfolios to take account of that.
So, portfolios are skewed toward fixed-income securities
and they are skewed toward the longer end of the yield curve,
longer-term securities, and we have seen a rise in interest
rates there. The rise that occurred last, I think, last spring
and summer is a possible foretaste of what could happen if
rates were to rise more sharply.
One of the things that is very difficult to do is to
predict when the rise might occur, how sharp it would be, and
exactly what its sources might be. Our job is to try to
identify what the impact of such a rise in rates might be. We
can conduct, or construct scenarios that might entail such a
rise in rates. Ten-year Treasuries, for example, are around
two-and-three-quarters percent. Other rates are aligned with
them. If they were to rise sharply, by 100 basis points or
more, that is in the ballpark of what we are talking about for
a sharp rise in rates.
That would create a shift in portfolio allocations. It
would create a shift in market expectations. It would spill
over into other parts of the financial markets as we saw last
summer.
Chairman Merkley. So, I think many folks might consider the
current low rates to be the anomaly and that a higher rate
might be more expected over time. But, my question, what is the
source of that higher rate? For example, if this is a change in
monetary policy that drives this, that is one factor. If it is
a loss of confidence in the ability of the U.S. Government to
pay its debts, that is entirely something different. Can you
spin out a couple scenarios that you have particular concern
about?
Mr. Berner. The Fed has been very careful about the way it
is conducting its monetary policy, and we have seen that the
Fed, even today, announced another adjustment in its monetary
policy, and the way they are doing that has not had a big
impact on interest rates. But, if circumstances change, then
the Fed may have to change, as well, and predicting when
circumstances might change is difficult. If we, ironically, if
we have faster growth, then rates could rise significantly. The
faster growth would be a great thing, more jobs, more growth,
more housing, more consumer spending.
If, on the other hand, rates rose because investors were
concerned about our creditworthiness, as you point out, that's
a different source. That would not be productive. And, in fact,
one of the risks we identify in our report is the lingering
uncertainty over our--the progress we are making or not on
dealing with our long-term fiscal problems. So, those are
factors that we consider in thinking about what the source of
an interest rate rise might be.
Chairman Merkley. Well, thank you.
Senator Heller.
Senator Heller. Thanks again, Mr. Chairman.
Doctor, I want to go back to what Senator Toomey was
talking a little bit about. You have done a good job, in my
opinion, to identify some of the concerns, repos, derivatives,
other exchange-traded funds that you look at in your concern
for certain activities. I guess my question, and going back to
what Pat said, was that you are an asset manager and,
basically, you have an agreement, an investment agreement, with
your client. What keeps that client from going from one asset
manager to another if they are recorded or designated a SIFI,
or perhaps even participating in this activity on their own?
Mr. Berner. Senator, nothing--it is true that if you do not
like the business you are conducting with one firm, you can
move your investments to another firm. But that is not really
what we are talking about. What we are talking about is
activities that are widespread across the asset management
industry that are engaged in by a number of firms, identified a
couple. If those activities were not very important and not
widespread, then, obviously, they would not be that important
for assessing risk to the entire financial system. But, because
they are widespread and because they are important and because
they do contain the potential for risk when stress arises in
the financial system, that is why I think we want to focus on
them in thinking about where the vulnerabilities to our system
might lie.
Senator Heller. OK. While you were working on your report,
was it your intent to make it public or a private report?
Mr. Berner. While we were working on the report, we thought
hard about the fact that we are committed to being transparent
and open and want to engage with the public and want to engage
to get comments on our work, and we certainly had no shortage
of those. We are always committed to making our work available
and public in many ways and many forms, and we want to be as
transparent as possible, so--and that is true when we engage in
meetings with asset managers in other firms. It is true when we
engage with the public in general. We want to make sure that we
are as open and disclosing as possible.
Senator Heller. So, if I understand correctly, are you
willing to commit that any future OFR research on this topic
will be made public, and also any future agency meetings, you
will disclose?
Mr. Berner. Well, Senator, if the Council asks us to do
work and it is work that we do on behalf of the Council, then,
you know--and it is the Council's property, then the Council
would have to make some of those decisions. We exist to serve
the needs of the Financial Stability Oversight Council, and if
that work is, in their judgment, something that is a draft or
predecisional or in other ways not appropriate because it might
contain confidential data, for example, for public
distribution, then the Council would have the final say.
However, I just want to make sure that you understand that if
it is appropriate to release information, if it is appropriate
to release our analysis, if it is appropriate to release data
that we have collected that bear on questions of financial
stability, then we are going to find a way to do that.
Senator Heller. Thank you.
Chairman Merkley. Thank you very much. I invite you to
conclude just by giving us some of your thoughts on the
challenging and complex issues related to financial stability
and the repo market.
Mr. Berner. OK. Thanks, Senator. The U.S. repo markets are
really, are very important for the functioning of our financial
system. They enable broker-dealers, investors, others, to
finance themselves in the public market on attractive terms.
They are used to finance securities transactions, as part of
that nomenclature indicates, and so they facilitate financial
transactions. They facilitate the ability of financial
intermediaries to engage in their basic risk taking, risk
pricing, risk management businesses. Unfortunately, as I
indicated earlier, those markets, as we learned in the crisis,
are subject to either runs or fire sales or both when they come
under stress, and those markets have many investors and many
borrowers. And so we need to look at all the investors, all the
borrowers, and thinking about where the stress points might
lie. In one of the three parts of the U.S. repo market, the so-
called tri-party market, there have already been put in place
by the Federal Reserve System several reforms that are making
that market stronger, the reduction of the intraday credit
exposure for the institutions involved in that market, the so-
called clearing banks. But, that market is still subject to
vulnerabilities under stress and those have been discussed
pretty well in a variety of places, both by us and the Fed.
There are two other parts to the market where we have--one of
them, at least, we have very little data. That is the so-called
over-the-counter or bilateral part of the repo market, which is
used not to transact in the way the tri-party market works,
through an intermediary, but directly between the borrower and
the lender. That is an area where we have very little clarity
and transparency about the transactions that are occurred on a
comprehensive, systemwide basis. It is an area where we are
working, as I indicated, with the New York Fed to collect more
data. But it is an area where we see, potentially, as we saw in
the crisis, even more dramatic adjustments to not just the
willingness to provide financing, but also in the terms and
conditions on which that financing is applied. Each of those
areas is one in which we want to investigate as we look at
these markets and try to figure out ways to make them more
stable.
Chairman Merkley. It sounds like we can anticipate that
your next Annual Report will continue to explore these issues
on the repo markets. I do want to thank you for your first
appearance before the Senate Banking Committee and for the
contribution that your research is making to the deliberations
of the FSOC and wish you well in your quest to help fill in
some of the data gaps and data analysis that can help us
understand better the vulnerabilities in our system. And with
that, I am going to adjourn the Subcommittee meeting, unless my
Ranking Member has anything else he would like to add.
Senator Heller. No, thank you.
Chairman Merkley. Meeting adjourned.
Mr. Berner. Thank you.
[Whereupon, at 4:26 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF RICHARD BERNER
Director, Office of Financial Research, Department of the Treasury
January 29, 2014
Introduction
Chairman Merkley, Ranking Member Heller, and Members of the
Subcommittee, thank you for the opportunity to testify today on behalf
of the Office of Financial Research about our 2013 Annual Report. \1\
This is our second report to Congress, fulfilling an annual requirement
to assess the state of the United States financial system and analyze
threats to U.S. financial stability.
---------------------------------------------------------------------------
\1\ The views expressed in this testimony are those of Richard
Berner, Director of the Office of Financial Research, and do not
necessarily represent the views of the President.
---------------------------------------------------------------------------
This is my first Senate hearing as OFR Director. Let me take this
opportunity to state my commitment to make the OFR a valued resource
for the Congress, the Financial Stability Oversight Council, and the
American people. Our annual report and my testimony are just two ways
we make our work known to our stakeholders. We are fully committed to
being transparent and accountable, and I look forward to future
opportunities to appear before you.
My testimony today will cover the four topics cited in your
invitation letter:
1. Our efforts to monitor financial stability and assess potential
threats to it;
2. The status of OFR data collection and analysis, and related data
security measures in place and under development;
3. Studies conducted and facilitated by the OFR; and
4. Coordination with relevant agencies.
Before I begin that discussion, I would like to step back and
review the core mission of the Office and the status of our efforts to
meet it.
OFR Mission and Status
The financial crisis revealed serious deficiencies in financial
data and in our understanding of vulnerabilities in the financial
system. A core part of the OFR's mission is to fill those critical gaps
in data and analysis for the benefit of the Financial Stability
Oversight Council (FSOC or Council) and, ultimately, the public. Our
mandate is not to duplicate work done at other Council member agencies,
but to complement their work--to provide the connective tissue that
will help us look across the financial system.
To assure transparency and accountability, we regularly engage with
our stakeholders in several ways. Our staff regularly briefs members of
Congress and their staffs. We also publish our studies through the 12
papers in our Working Paper Series and our two annual reports, and make
them available on our Web site. We have also developed our Web site to
be user-friendly and a growing source of content. We routinely make
public presentations to industry, academia, government, and public
interest groups in order to share our research insights and receive
feedback from the broader community. We invite outside experts to
seminars to share and debate their findings and sponsor conferences to
engage with the public. In the past year, we jointly sponsored three
such meetings with the Council and the federal reserve banks of
Cleveland and New York.
The structure of the Office assures a balance between this
transparency and accountability on one hand, and autonomy on the other.
The OFR is an office within the Treasury Department. However, it is
unique among Treasury offices. The integrity and independence of the
Office's work is protected by statute. The Office serves the Council
but is separate from it. In particular, the OFR does not make policy,
the Council does. That puts us in an objective position to analyze
threats to financial stability and to evaluate policies to mitigate
them.
To ensure objectivity, our Congressional testimony and, by
extension, our research, must be independent. Under the statute, no
officer or agency of the United States can require the OFR Director to
submit Congressional testimony for approval, comment, or review prior
to delivery to Congress.
In creating the OFR, the Dodd-Frank Act prescribed other key
differences from the Treasury. The OFR is funded by assessments on
certain financial companies. The OFR's pay and employee benefits are
comparable to those of other federal financial regulators. At the same
time, the law requires the Director to consult on the OFR budget,
hiring, employee compensation, and other matters with the Council
Chair, who is the Secretary of the Treasury.
The Office has developed rapidly during the 18 months since we
released our first annual report. In addition to our headquarters here
in Washington, DC, we have a satellite office in New York City to
engage closely with market participants. Our workforce now stands at
more than 190 employees, up from only 30 in fiscal 2011. By fiscal
2015, we plan to reach a full staff of about 280.
As we have grown, we have refined our management structure and our
policies and procedures to help us carry out our mission. For example,
we established an office of External Affairs, led by a member of our
senior management team, to coordinate engagement with external
stakeholders and partners in Government. Building on the strategic
framework that we released in March 2012 to cover FY2012-14, we are
working on a new, 5-year strategic plan to take effect in FY2015. The
strategic goals in both plans are tied to objectives, outcomes, and
performance measures that will focus our work and keep us accountable
to ourselves and the public.
We no longer talk about standing up the OFR. Today, the OFR is not
only standing on its own, but is making important contributions to
promote the stability of the U.S. financial system.
OFR Annual Report
The OFR and the Council produce annual reports at 6-month
intervals. The two reports cover similar ground but take different
approaches. The Council report takes a comprehensive view of
vulnerabilities and recommends ways to strengthen the financial system.
It is a consensus report, signed by all Council members. In contrast,
our report dives more deeply into data and research issues related to
those vulnerabilities. We provide an independent assessment of the
state of the U.S. financial system, although we solicit and incorporate
feedback from Council member agencies and other subject matter experts.
The OFR's 2013 Annual Report contains analyses that focus on
analyzing threats to financial stability, evaluating macroprudential
policy, presenting findings of OFR research on financial stability
(specifically, financial contagion, market liquidity, and
interconnections among financial institutions and markets), addressing
data gaps and OFR's efforts to fill them, and promoting data standards,
such as the Legal Entity Identifier. The report also discusses the
status of the Office in achieving its mission, and concludes with our
future research and data plans.
Monitoring Financial Stability and Potential Threats
Thanks to an array of policy measures and industry actions, the
U.S. financial system has grown stronger and more stable since we
issued our inaugural annual report in July 2012. However, the financial
crisis taught us never to be complacent about a potential buildup of
risks that can damage the financial system and the economy. Threats to
U.S. financial stability persist and we must remain vigilant.
Today's environment of persistently low interest rates and low
volatility might seem benign, but this environment can breed
complacency. It can encourage market participants to take more risks
and employ more leverage to achieve desired returns. Those, in turn,
increase potential vulnerabilities to shocks, such as sharp increases
in interest rates and jumps in volatility.
The weaknesses in the financial system are often hidden--becoming
obvious only when shocks expose them. Our job at the OFR is to try to
identify and assess the vulnerabilities before shocks hit.
We are developing a new tool--our prototype Financial Stability
Monitor--to identify and monitor these threats and to assess the
interplay among them. This new monitor, a heat map, tracks five
functional areas of risk: macroeconomic, market, credit, funding and
liquidity, and contagion. We consider this breakdown best for looking
at risks across the financial system and identifying causes rather than
just symptoms. We quantify risks through a mix of economic indicators,
market indexes, and measurements that we calculate.
This monitor is the first version of a tool that we will refine and
improve over time. One limitation of Version 1.0 is that our current
set of metrics largely tells us where we are, not where we are going.
To address that, we are working to incorporate new, forward-looking
indicators into our framework.
Informed by this monitor, we have identified a range of potential
threats to financial stability. The first four are closely related and
often occur together.
1. Disruptions in wholesale funding markets, such as repurchase
agreements, or repo.
2. Exposure to a sudden, unanticipated rise in interest rates.
3. Exposure to shocks from greater risk-taking in a low-volatility
environment.
4. Exposure to a sudden shock to market liquidity.
5. Excessive credit risk-taking and lax underwriting standards.
6. Operational risk from automated trading systems, such as high-
frequency trading.
One additional risk is worth discussing in light of the events of
the past week. Recently, emerging-market currency and asset markets
have come under significant pressure, and such stress has spilled over
quickly into global markets for risky assets, such as equities. In our
2013 Annual Report, we highlighted emerging-market vulnerabilities,
including those that have played out in financial markets in the last 2
weeks. We are monitoring these developments carefully.
In Chapter 4 of our annual report, we summarize OFR research
projects on new tools for measuring and monitoring market liquidity
(examining the measurement of liquidity shocks across asset classes)
and network analysis to improve our understanding of contagion among
financial firms exposed to each other.
Macroprudential policies are those aimed at reducing contagion and
other vulnerabilities that span the entire financial system. They
address threats that cut across financial institutions and markets, and
are designed to reduce the likelihood and severity of financial crises.
The Dodd-Frank Act requires us to evaluate macroprudential
policies. In Chapter 3 of the report, we outline a framework for
evaluating such policies. Since the financial crisis, U.S. regulators
have expanded the macroprudential toolkit, for example, through
supervisory stress tests. Further improvement to stress tests would
incorporate funding risks, potential spillovers, and feedback effects
to increase value for financial stability assessments.
Data Collection, Standards, Analysis, and Security
Filling data gaps. A key mandate for the OFR is to improve the
scope and quality of financial data. To better measure financial
activity and thus better understand how the financial system works--its
interconnections, its vulnerabilities, and its risks--we are engaged in
several projects to fill data gaps.
A critical step in filling data gaps involves taking stock of
existing data. To that end, we have produced and recently published the
public portion of an Interagency Data Inventory on the OFR Web site.
The OFR produced the inventory in collaboration with the FSOC Data
Committee.
The inventory is a catalog of the data that FSOC-member agencies
collect from industry that we will update regularly. It contains a
listing of datasets, or ``metadata,'' not the data themselves. The
public portion posted on our Web site excludes information about
nonpublic data, including those derived from other data.
The inventory is essential for identifying gaps in data, avoiding
duplication in future requests for data from industry, and improving
research and analysis to understand threats and vulnerabilities in the
financial system. It is thus a key building block in the OFR data
analysis and reporting architecture.
Chapter 5 of our annual report discusses data gaps in detail. It
assesses gaps related to short-term funding markets and related
financial activities, explains why filling gaps in data related to
these markets is a top priority, and describes ways we will fill them.
In 2014, we are working with the Federal Reserve Bank of New York to
improve and expand data that measure activity in such markets, like
repo and securities-lending activities.
Data standards. High-quality data are critical for good decision
making. Data standards are essential to assure data quality, and thus
for comparing, aggregating, linking, and analyzing data. Their adoption
will improve data quality and reduce collection costs and duplication.
What are data standards? They are rules that help precisely
identify parties to financial transactions, precisely define financial
instruments and how they relate to one another, and precisely specify
how data should be collected. Standards for collection specify the data
fields for collected data and the formats in which they are collected.
In the same way that templates are used to collect address information
with separate fields for street, city, state, and zip code, the use of
standards improves data management and the quality of analysis.
We are making needed investments in the development and
implementation of data standards. Chapter 6 of our annual report
describes the framework we have developed for creating and promoting
data standards. Not surprisingly, a key conclusion is that to be
effective, standards should be adopted universally. We all need to use
the same standards, or alternatively to be able to translate one set of
standards smoothly into another. More work is needed, and I ask for
your support to promote their use.
The report also describes progress on implementing the Legal Entity
Identifier (LEI), a global standard like a bar code for uniquely
identifying parties to financial transactions. OFR leadership in the
initiative to establish and promote the use of the LEI includes serving
as Chair of the LEI's Regulatory Oversight Committee.
The LEI's benefits are huge. Precise identification of
counterparties would give firms a clearer picture of their exposures in
the marketplace. Estimates from financial industry sources suggest that
use of the LEI will save billions of dollars that the industry now
spends on cleaning and aggregating disparate data and on reporting data
to regulators.
For financial regulators, the LEI would assist in data aggregation
and comparisons, thus help in identifying vulnerabilities in the
financial system and providing insight into ways shocks can spread
across financial markets.
Given those benefits, the case for universal adoption of the LEI
system is strong. We are collaborating with primary regulators to
achieve broader implementation of the LEI in U.S. financial reporting,
to sync with efforts abroad. I call on regulators in the U.S. and
around the world to require use of the LEI through regulatory
rulemaking.
The need for data standards also extends to financial products. For
example, a universal mortgage identifier (UMI) is clearly needed.
Mortgage debt represents 70 percent of U.S. household liabilities. The
mortgage finance system is complex and the data produced by this system
are fragmented. A single UMI would bring coherence to these data and
would significantly benefit households, industry, regulators, and
researchers.
We call for the establishment of a single, cradle-to-grave,
universal mortgage identifier that protects the privacy of the
borrowers. With substantial input from industry and several agencies,
we have just published an OFR working paper that discusses the
characteristics that a UMI should have and criteria for implementation.
Industry participants strongly favor the LEI and the UMI to help
make their internal data and their reporting activities coherent and
efficient.
In another initiative, we are engaging with the Commodity Futures
Trading Commission (CFTC) to design and use standards to improve the
quality of data collected from trade and swap data repositories.
Data analysis. Our annual report contains preliminary results of
OFR research using newly available, highly granular data. For example,
our analysis of money market fund investments enables us to assess the
factors triggering the large decline in U.S. money fund holdings of
European bank liabilities during the European sovereign debt crisis. An
analysis of the sovereign credit default swap market enables us to
identify the sellers, market makers, and buyers of credit protection,
and thus to locate sources of risk. We also analyzed hedge fund
leverage using aggregated data from Form PF. These aggregated data
suggest that hedge fund use of leverage is inversely related to the
liquidity of, and the risks in, assets in the funds' portfolios.
Data security. No OFR goal is more important than safely and
securely collecting data and safeguarding the data we hold.
OFR information security standards are governed by those of the
Treasury, and our Chief Information Security Officer works closely with
his Treasury counterpart to assure that our policies and procedures
meet or exceed the standards of the Treasury Department, as well as the
standards of Council member organizations.
To support OFR staff research and to clean, manage, and store
large-scale datasets, we have made substantial progress in building our
technological infrastructure and the analytical environment that will
house our data and give our researchers the advanced tools they need to
conduct innovative research.
Our information security standards are fundamental to this new
technology infrastructure, verifying access permissions at the most
granular level. Technology is necessary but insufficient alone to
assure security, so the systems we are building for data acquisition,
management, and dissemination are accompanied by strict and clear rules
for data security and data sharing.
As required by the Federal Information Security Management Act, the
Office has established an information security program policy and data
handling procedures for proper safekeeping of information at the
highest level of the Federal Information Processing Standards. Our
program also includes postemployment restrictions for employees who
handle sensitive information.
In addition, we are expanding security controls for sharing
information among Council member agencies, collaborating to forge
bilateral data-sharing agreements to assure all participants that
shared data will be protected, secured, and treated consistently. The
agreements are consistent with the analysis of Council data sharing by
the Council of Inspectors General for Financial Oversight.
For data-sharing agreements to work, agencies must agree on
information security classifications and how to apply them. For
example, different agencies may have had different policies for
handling data defined as ``restricted'' or ``high security.'' The
Office led an initiative by the Council Data Committee to ``crosswalk''
security classification categories. An interagency working group
established a common framework for information security practices,
processes, and compliance requirements.
The National Institute of Standards and Technology assisted the
working group in aligning the framework with the Federal Information
Security Management Act of 2002 and the Federal Information Protection
Standards. These federal standards represent the common base to which
all federal agency classifications are mapped.
OFR Studies Conducted and Facilitated
The OFR has conducted and facilitated a wide range of studies in
support of its mission. For example, our Working Paper Series is
designed to inform the process of assessing, measuring, monitoring, and
mitigating threats to financial stability. In addition to the paper
about the Universal Mortgage Identifier, discussed above, we have
released a paper assessing contagion in financial networks and several
papers on the theory and practice of stress testing.
The OFR has also conducted analysis for the last two FSOC annual
reports. We have also facilitated analysis for the Council, such as
evaluating the risks of money market funds and data related to the
process of designating nonbanks for supervision by the Federal Reserve.
In the international arena, the OFR contributes to work streams of
the Financial Stability Board on ways to improve data quality in swap
data repositories and data gaps in shadow banking.
In September 2013, we released Asset Management and Financial
Stability, a report on asset management summarizing the results of a
study requested by the Council. We designed the report to inform the
Council's consideration of what threats in asset management activities
exist and what remedies, if any, might be appropriate to mitigate any
such threats.
The report had three key findings:
Asset management activities and firms differ from banking
activities and banks. To quote the first page of the report,
asset management activities ``differ in important ways from
commercial banking and insurance activities. Asset managers act
primarily as agents: managing assets on behalf of clients as
opposed to investing on the managers' behalf. Losses are borne
by--and gains accrue to--clients rather than asset management
firms. In contrast, commercial banks and insurance companies
typically act as principals: accepting deposits with a
liability of redemption at par and on demand, or assuming
specified liabilities with respect to policy holders.''
Vulnerabilities in some activities could give rise to
threats to financial stability, in particular, risk-taking in
separately managed accounts and the reinvestment of cash
collateral in securities lending transactions.
Significant data gaps hamper analysis. Filling them would
be essential to verifying our findings.
It is also important to note what the report did not do:
It did not evaluate individual firms. Any designation
process by the FSOC would involve evaluation of individual
firms. The OFR report did not focus on individual firms, but
instead on asset management activities. As a result, the OFR
report alone could not be used as the basis for designating any
particular firm.
It did not substitute for the Council's work. The goal of
the report was to provide information. The Dodd-Frank Act
established the OFR as a research and data organization with
the mandate to support the Council and its member agencies in
their efforts to identify and mitigate threats to financial
stability. Responding to the Council's request for this
analysis is part of fulfilling that mandate. However, the OFR's
responsibilities do not extend to deciding on policy actions.
The OFR Director is a nonvoting member of the Council and only
the voting members of the Council decide on the specific
threats posed by any activity and whether any remedies are
necessary to mitigate such threats.
Finally, it is important to note that the OFR followed an open and
transparent process in gathering information for the report:
The OFR research team met with representatives from the
asset management industry on numerous occasions. Not only did
we grant every request from the industry to meet, but we
actively sought meetings with industry representatives to learn
as much as possible about industry business models and
practices.
The OFR research team engaged with experts from FSOC member
agencies throughout the entire course of the process, including
extensive interaction with experts from the Securities and
Exchange Commission (SEC). Many important contributions from
those experts appear verbatim in the report.
Sponsoring research. We do not conduct our research and analysis in
a vacuum. On the contrary, we seek to create a virtual research
community to promote and sponsor world-class research by exchanging and
testing ideas. The conferences, workshops, seminars, and public
appearances that I mentioned earlier serve as incubators for generating
new ideas about promoting financial stability and making our financial
system safer.
Another such incubator is our Financial Research Advisory
Committee, 30 distinguished professionals in economics, data
management, risk management, information technology, and other fields
who provide expert advice to the OFR and bring diverse perspectives to
help the OFR fulfill its mission. In August 2013, the committee
submitted its first set of recommendations to the OFR; these
recommendations and the proceedings of the Committee are posted on our
Web site.
We have also established a program for sponsoring research through
grants. In May 2013, we announced our partnership with the National
Science Foundation to sponsor novel research related to financial
stability. The first grant was awarded in September 2013 for a project
to examine the impact of high-speed trading on the financial system.
This research promises to yield additional insights into working with
extremely large financial datasets in a supercomputing environment.
Researchers at the University of Illinois at Urbana-Champaign and the
San Diego Supercomputing Center are conducting the research.
Coordination With Relevant Agencies
Interagency coordination is part of the OFR's every day routine in
engaging with FSOC member agencies and others. Examples include our
extensive coordination with relevant agencies on our asset management
report, on data sharing, in seeking input from agencies on other
research-related publications, and in providing subject-matter
expertise to them.
The OFR leads the FSOC's Data Committee, which handles issues
related to data collection, gaps, and standards. We are also supplying
data and analysis to the FSOC Systemic Risk Committee and the Nonbank
Designation Committee.
Before publishing a research working paper or annual report, we
solicit feedback from subject matter experts in academia and at FSOC
member agencies and other financial regulators, such as the Federal
Reserve Bank of New York.
We are also collaborating with the SEC on cleaning and analyzing
data from Form PF, which is submitted by hedge funds and other private
funds and, as I mentioned, we are engaging with the CFTC to improve the
quality of data reported to swaps data repositories.
As I already mentioned, we are also collaborating with Council
member agencies through the Council's Data Committee to promote data
sharing, consistent with the strictest security measures.
Conclusion
As the financial system changes, evolves, and innovates, new
threats and vulnerabilities continuously emerge. At the OFR, we face
the challenge every day of filling gaps in data, and conducting and
sponsoring essential research that will help us not only understand the
financial system of today, but also identify the vulnerabilities that
could ensnare our financial system and economy tomorrow.
It is critical for Congress and the American people to receive
timely and accurate information about our essential work. That is what
makes venues such as this hearing so important.
Thank you again for the opportunity to appear today. I would be
happy to respond to your questions.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM RICHARD BERNER
Q.1. What additional disclosures, reporting, limits, or other
actions could mitigate concerns about asset manager exposures
in the derivatives market?
A.1. As we noted in our Asset Management Report and our recent
Annual Report, the OFR is working with the SEC and other
members of the Council to analyze the Commission's Form PF in
an effort to understand and address remaining data gaps and
improve disclosures in asset management activities. In
addition, the OFR is working with the CFTC to identify ways to
improve the quality of the data describing derivatives
transactions and exposures that are being collected by swaps
data repositories, and is also engaged on the international
level to better align swaps data collections to provide a more
precise and coherent global view of these markets.
Higher-quality data are needed to improve the understanding
of exposures in both derivatives markets and in the securities
lending and repo activities described in the response to the
next question. The OFR believes that implementation of a common
data template would help improve data quality; it should meet
the following requirements:
The data template should be based on a clear
dictionary of data definitions to ensure effective and
consistent data aggregation across multiple types of
market participants;
reporting periods should be consistent across all
firms where feasible;
reporting frequency and timeliness should ensure
that potential market dislocations are captured;
data elements should provide the common minimum set
of standards for U.S. regulatory agencies.
Any such data initiatives should also be designed with
consideration of market structure and scale, and should build
upon existing data collection processes and market
infrastructures. For example, collecting transactions-level
data for exchange-traded derivatives may be best accomplished
through financial market utilities, including swap data
repositories.
The OFR has not conducted analysis of potential mitigating
actions that regulators could take in this area.
Q.2. What elements should be included in any reporting
requirements pursuant to Section 984 to fully inform regulators
of the risks involved in securities lending activities? Would a
rule under Section 984 require disclosure on all types of
securities lending and all relevant parties, or could holes
remain?
A.2. The OFR is seeking to close the data gaps related to both
securities lending and repo activities; they have many features
in common. Steps in that project include ongoing analysis of
the short-term funding markets, input from the largest and most
interconnected market players, and, involvement in other
efforts to learn more about the securities lending activities
managed by the largest custodian banks.
Additional disclosure requirements could be helpful. These
could include information on the type of securities lent, the
amount of cash collateral held related to securities lending
and how it is managed, rebates paid to securities borrowers,
the percentage of securities for which the firm provides an
indemnity in the event a borrower is unable to return the
security, securities borrowed, and counterparties the asset
manager works with for securities lending transactions.
Q.3. Have prudential regulators expressed concerns about the
types and concentration of reinvestment of cash collateral
undertaken by securities lenders? If yes, does OFR plan to work
with these regulators to address concerns about reinvestment of
cash collateral? If not, do regulators feel that cash
collateral reinvestment practices are sufficiently sound to
protect both fund assets and securities borrowers, and does OFR
agree with this assessment?
A.3. Since the financial crisis, the scope of securities
lending activities has decreased substantially. Many lenders
who sustained losses have exited their securities lending
programs. Collateral reinvestment practices have been reviewed
to ensure better risk management. Nevertheless, U.S. regulators
continue to express concern about cash collateral reinvestment
activities undertaken by securities lenders--see for instance
the FSOC 2013 Annual Report (pages 68 and 144) and
contributions to reports from the Financial Stability Board.
The concern stems from two sources: First, that under stress,
such reinvestment transactions might be unwound quickly,
resulting in fire-sale conditions; and second, that regulatory
agencies lack reliable, detailed data on reinvestment
activities and specific investment practices. The OFR's
analysis of market sources indicates that reinvestment
practices vary widely. We will continue to investigate and
monitor these issues and we will work with regulators to
address their concerns.
