29 01, 2024

Karen Petrou: The Risks New Capital Rules Can’t Cure

2024-01-29T09:29:45-05:00January 29th, 2024|The Vault|

Part one of my end-game assessment was last week’s memo laying out the growing odds that the agencies will be forced to issue a new proposal which hopefully makes better sense than the current one.  Part two here points out how the agencies have so tightly wrapped themselves around the capital rule’s axle that they are unable to see how many even more critical challenges are going unaddressed.  Risks overlooked are often risks even the toughest capital rules cannot contain because the cost of new capital rules actually contributes to the arbitrage and risk-migration accelerating the pace of systemic-risk transformation.  This is a negative feedback loop if ever there were one.

The new capital rules will be outdated by the time they are finalized because financial institutions of all persuasions will take advantage of every bit of regulatory-arbitrage opportunity within and across borders.  That the banking agencies and FSOC aren’t even thinking about how this might happen makes it still more likely that they will.  This is not to say that no changes to capital rules are warranted.  Some changes are overdue, but capital rules crafted in a vacuum will not stand up to real-world circumstance.

The collective book reports issued by the Federal Reserve in its semi-annual systemic forecast and the FSOC’s annual reports are remarkably backward-looking.  Focused more on not saying anything too frightening and bolstering ongoing initiatives, these tomes have long been and sadly still are poor auguries of risks to come perhaps all too soon.

Even …

11 04, 2022

Karen Petrou: Why the Gerontocracy is Right about DeFi Risk

2023-03-02T11:37:03-05:00April 11th, 2022|The Vault|

When we started our own analyses of technology-based finance’s stability and equality implications in 2019, we were among the first to focus on disclosures, conflicts of interest, and even self-dealing.  Still, we had no idea how many sides of a trade someone could quietly be on if he or she builds out something that purports to be decentralized finance (DeFi) but is anything but.  Although regulators have yet to do much about it, their first in-depth DeFi report details a raft of risks they should quickly remedy.  Odds are that they won’t until innocent investors and bank customers lose many of their millions, but this too-many-rules-far-too-late habit is particularly dangerous when it comes to fast-moving DeFi.

First and foremost, DeFi isn’t nearly as decentralized as those touting it represent.  If DeFi were truly decentralized, then it would be a lot harder for hackers to make off with everything in a DeFi platform in one swipe, but this has a nasty habit of happening over and over again.  As a result, at its most essential, DeFi exposes counterparties and customers to loss of assets even if nothing else goes amiss.

And much else could.  As the report from the International Organization of Securities Commissions details, DeFi is not only often centralized, but also not even all that digital.  Non-digital and centralized aspects of DeFi include not just graphical interfaces with customers and fiat-currency transactions with counterparties, but also very traditional forms of finance such as leveraged trading and rehypothecation …

29 03, 2022

FedFin: Global Securities Regulators Diss DeFi

2023-03-27T15:46:19-04:00March 29th, 2022|The Vault|

As promised, this report provides an in-depth analysis of IOSCO’s new paper on decentralized finance, one sure to advance the FSB’s efforts to bring DeFi systems under greater regulatory scrutiny due to the findings we here detail.  In the U.S., President Biden’s crypto-focused executive order (see FSM Report CRYPTO26) highlights DeFi’s risk with regard to illicit finance.  IOSCO’s work on this report was headed by the SEC, suggesting rapid U.S. action not only on this concern, but also on many other risks by the Commission, as well as the FSOC and other U.S. agencies…

The full report is available to retainer clients. To find out how you can sign up for the service, click here.…

18 10, 2021

FedFin on: Global MMF-Reform Options

2023-06-07T15:52:59-04:00October 18th, 2021|The Vault|

Global regulators have now finalized a framework on which national regulators may base the reforms they deemed necessary after the pandemic sparked profound disruptions in this sector.  However, as with the FSB’s proposed approach, the final framework sets few parameters for jurisdictional action beyond a strong plea for action of some sort that would meaningfully address the redemption and/or liquidity risk the FSB continues to believe presents a threat to national and even global financial stability.

The full report is available to retainer clients. To find out how you can sign up for the service, click here.…

18 10, 2021

Karen Petrou: How to Make Stablecoins More than Monopoly Money

2023-06-07T15:59:53-04:00October 18th, 2021|The Vault|

In all of the reports on all of stablecoin’s risks that so frighten central bankers and global finance ministers, none is as terrifying as whether the assets backing hundreds of billions of dollar-equivalent transactions are to be had when needed.  And needed they will be – see not just all the ministerials on high, but also Gillian Tett’s latest, compelling FT column.  Without a meaningful reserve-currency reference, stablecoins are the equivalent of monopoly money without even the teeny little plastic hotels providing an illusion of wealth.  Making stablecoins matter as real money requires meaningful reserves but meaningful reserves mean that stablecoin’s gung-ho promoters won’t get anywhere near as rich.  The business model changes for the way-better, but the construct of stablecoins may be so altered as to make this looming systemic phenomenon only a passing fancy.

The set of difficult choices needed to realize stablecoin’s promise to anyone but profiteers is detailed in our latest report on critical policy issues.  In it, we analyze a set of systemic-risk principles recently proposed by the BIS’s Committee on Payment and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO).  As is usually the case with global-regulatory pronouncements, this proposal defines wide parameters for jurisdiction action, stating most clearly what’s wanted, not what will happen if one were actually to get it.

The CPMI/IOSCO paper is even more hesitant than usual because reserve assets aren’t stablecoin’s only tricky bit.  For example, the paper describes a governance conundrum of formidable proportions …

14 10, 2021

FedFin on: Global Systemic-Risk Standards for Stablecoin Arrangements

2023-06-15T14:58:37-04:00October 14th, 2021|The Vault|

Responding to requests from the G7, G20, and FSB, this report addresses market-infrastructure considerations related to systemically-important stablecoins that do not involve multi-currency baskets (e.g., Facebook’s Diem).  The report builds on the FSB’s current principles and those on cross-border payments, but generally does not propose specific standards.  Instead, it lays out how current global principles in this area should guide both stablecoin developers and regulators.

The full report is available to retainer clients. To find out how you can sign up for the service, click here.…

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