Regulators Worry New Rules May Freeze Markets
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Nearly five years after the passage of the Dodd-Frank Act, regulators are beginning to question whether the cumulative effect of the rules authorized by the law are hurting market liquidity — and if that could pose a systemic risk. Speaking before the Brookings Institution this week, Office of Financial Research Director Richard Berner said that the financial reform law and related regulations could “be contributing to more permanent adjustments that could impair market functioning,” including by reducing market liquidity. Karen Shaw Petrou, managing principal of Federal Financial Analytics, said that it’s clear liquidity in fixed-income markets has been impaired, though it’s uncertain how much of that impairment is due to regulation, algorithmic trading, low interest rates or other factors. Regardless of the cause, she said, there are some things that have been suggested as possible actions regulators could take to improve liquidity if they chose. For one, regulators could revise certain aspects of the Basel III accords, specifically the rules outlined in the supplemental leverage ratio. The 5% capital requirement for investment-grade single-named credit default swaps and 10% capital charge for high-yield swaps is making those products too expensive to trade, Petrou said, though demand for them persists. Petrou said another idea that has been floated, albeit a problematic one, is making the Fed “market maker of last resort,” effectively having the Fed step in and create liquidity if no one else will.
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