In the puzzle of oncoming financial regulation, how to properly oversee a firm’s liquidity is one of the largest pieces regulators are now working to get right.
But those efforts have not been easy, regulators and industry experts conceded at audit, tax and advisory firm Grant Thornton LLP’s Broker-Dealer Symposium in New York on Tuesday.
“With respect to the amount of capital that has to be maintained, it’s a challenge for regulators to get that right,” said Grace Vogel, executive vice president of member regulation at the Financial Industry Regulatory Authority, or FINRA. “We haven’t come up with a better answer than value at risk models for trading assets.”
Having substantial liquidity has been a focus since the financial crisis and subsequent Basel III reforms. Fresh examples of post-crisis liquidity concerns have come with J.P. Morgan’s $2 billion trading loss and MF Global, which ultimately collapsed after it saw its liquidity worries mount with investor fears in October.
The problem with value at risk models, according to Vogel, is that they are right 99% of the time. Out of 100 days, that means that one day will have losses that exceed the model. As a result, she said, the Securities and Exchange Commission and the Commodity Futures Trading Commission have set minimum capital requirements.
But adequately meeting minimum capital requirements might not be enough to save firms from liquidity concerns, said Steven Lofchie, a partner in the financial services department at Cadwalader, who called it a “great lesson of the crisis.”
“It was clearly an issue with liquidity, and I don’t know that we’re actually dealing with it directly,” Lofchie said of current regulatory reform efforts.
Coordinating regulation on liquidity has been challenging, Vogel conceded, because each regulator is interested in having excess liquidity in the legal entity that they are responsible for regulating.
“Although we have tried to come up with a meeting of the minds with other regulators, this has been one area where it has been quite difficult,” Vogel said. “There is a lot more communication with banking regulators than with the international regulators. But unfortunately, everyone’s priority is the legal entity they regulate.”
But overall, Kevin Piccoli, deputy director of the Division of Swap Dealers and Intermediary Oversight at the Commodities Futures Trading Commission, said the coordination among the securities regulators has been terrific.
“I think there is a lot of communication, coordination, a lot of positive conversations, and all looking to do what is right,” Piccoli said.
Another topic up for debate at Tuesday’s session was the JOBS, or Jumpstart Our Business Startups Act, which is aimed at boosting small businesses and funding to them by deregulation.
The legislation is an example of “regulation by randomness,” Lofchie said, because of the tremendous burden of regulation that Dodd-Frank has imposed on other business areas.
But that legislation is an example of the tradeoffs that come with securities regulation, said Lanny Schwartz, partner at Davis Polk & Wardell. The act may allow small businesses to more easily raise capital and access the IPO market, he said.
“If we as a society decide right now a little bit more jobs is worth loosening the reigns a little bit in terms of formalities of capital raising, maybe that’s not such a bad choice,” Schwartz said.