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International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories
and world events that (for better or for worse) shaped the
week's agenda, and what is next
Dear Member,
I have enjoyed Umberto Eco's book
"The Name of the Rose".
Eco writes: "The list could surely go
on, and there is nothing more
wonderful than a list, instrument of
wondrous hypotyposis"
I have also heard that an intelligent
person armed with a checklist is no
substitute for experience.
Today we have another interesting approach from Jay D. Hanson, PCAOB
Board Member: “With an increase in checklists to complete, some fear that
much of the judgment and thinking has been removed from the audit and,
as a result, audit quality can suffer.
However, I don't believe that checklists can or should take the place of
thought and judgment, and I do not believe that audit firms intend them to
do so.
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Imagine a pilot of an airplane having the attitude that the extensive
preflight checks they complete are just a "compliance exercise" that does
not require careful attention or the exercise of judgment to go above and
beyond the list when something seems just a bit "off."
I would not want to fly on that plane.
Another area where checklists are becoming more common are operating
rooms in hospitals around the world.
Studies show that such checklists reduce errors and improve patient
outcomes.
But nobody would suggest that the checklists could take the place of the
surgeon paying careful attention during the surgical procedure and using
experience and judgment to protect the patient's best interests.
The bottom line is that checklists can be a great addition to help navigate
complex processes, but they should not take the place of judgment.
They are reminders of all the things you need to think about, but you still
need to think — about the various paths you can take, the potential
outcomes that may result, and, as an auditor, what would be in the best
interests of investors.
After all, you and those who came before you did not spend five years
studying, so that you can stop using your brain when you start your
professional career.”
Read more at Number 1 below.
Another development: The Board of Directors of the Bank for International
Settlements (BIS) has announced the appointment of Luiz Awazu Pereira
da Silva as Deputy General Manager from 1 October 2015 for a five-year
term.
Mr Pereira da Silva will succeed Hervé Hannoun when he retires at
end-September. Mr Hannoun has served as Deputy General Manager since
2006.
Mr Pereira da Silva has been Deputy Governor at the Central Bank of Brazil
since 2010. Prior to this, he served in several senior positions, inter alia at
the World Bank, and as Chief Economist for the Brazilian Ministry of
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Budget and Planning, and as Brazil's Deputy Finance Minister in charge of
international affairs.
A Brazilian national, he holds a PhD in Economics and a Master of
Philosophy from the Université de Paris-I Sorbonne, Paris, France.
Welcome to the Top 10 list.
Best Regards,
George Lekatis
President of the IARCP
General Manager, Compliance LLC
1200 G Street NW Suite 800,
Washington DC 20005, USA
Tel: (202) 449-9750
Email: [email protected]
Web: www.risk-compliance-association.com
HQ: 1220 N. Market Street Suite 804,
Wilmington DE 19801, USA
Tel: (302) 342-8828
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Regulators, Checklists and Navy SEALs: A
Collection of Thoughts for Future Accountants
Jay D. Hanson, Board Member
Beta Alpha Psi, West Lafayette, IN
“I started my own career in accounting over 35 years ago as a public
accountant at a large accounting firm, and I have enjoyed the varied paths I
have been able to explore since that time.
For the past four years, I have been at the Public Company Accounting
Oversight Board, where I have experienced many things I could not have
imagined when I graduated from college.”
How can prudential regulation foster growth?
Speech by Ms Sabine Lautenschläger, Member of the
Executive Board of the European Central Bank and
Vice-Chair of the Supervisory Board of the Single
Supervisory Mechanism, at the Frankfurt Finance
Summit, Frankfurt am Main
“Supervisors can contribute to sustainable economic growth by ensuring
that supervised entities are resilient to plausible shocks, properly managed,
adequately capitalised and subject to an efficient risk management and the
right incentives.
The European Single Supervisory Mechanism takes a medium to long-term
perspective on this, resisting those who argue for short-term relief.
The SSM ensures that banks can deliver in their tasks in all phases of the
economic cycle and thus are able to provide the economy with the financial
services that corporations, smaller firms and citizens need.”
“The Supervisory Review and Evaluation Process (SREP) gives us the
instrument to tailor supervisory requirements beyond the minimum capital
requirements set by the Basel Accord.”
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President's address at the 16th ECB and its
Watchers Conference
Speech by Mr Mario Draghi, President of the European
Central Bank, at the conference "The ECB and Its
Watchers XVI", Frankfurt am Main
“In January, the ECB decided to expand its asset purchase programme to
include government bonds after it became clear that there was a need for
more monetary stimulus.
Asset purchases are unconventional, but not unorthodox, and they have
been part of the ECB's toolkit from the start.”
DARPA “BRANDEIS” program for online privacy
and security
“Effort seeks to bolster ability to protect vital networks and
sensitive data
DARPA announced plans to research and develop tools for
online privacy, one of the most vexing problems facing the
connected world as devices and data proliferate beyond a
capacity to be managed responsibly.
Named for former Supreme Court Justice Louis Brandeis, who while a
student at Harvard law school co-developed the concept of a “right to
privacy” in a seminal article under that title, the new program seeks to
explore how users can understand, interact with and control data in their
systems and in cyberspace through the expression of simple intentions that
reflect purpose, acceptable risk and intended benefits such as "only share
photos with approved family and friends.”
The right to privacy, as Brandeis argued in 1890, is a consequence of
understanding that harm comes in more ways than just the physical.
Brandeis was reacting to the ability of the “instantaneous camera” to record
personal information in new ways.”
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Revision of the FINMA Anti-Money
Laundering Ordinance
The Swiss Financial Market Supervisory Authority FINMA has opened a
consultation on the draft revised version of the FINMA Anti-Money
Laundering Ordinance.
The FINMA Anti-Money Laundering Ordinance (AMLO-FINMA) has been
in force in its current form since 1 January 2011.
Critique of the financial crisis decisions of
end-September 2008 - my views
Introductory statement by Mr Patrick Honohan,
Governor of the Central Bank of Ireland, at the
Oireachtas Banking Inquiry, Dublin
“There are several features of the decisions at end September that can be
criticised even allowing for the limited information then available to the
decision makers.”
Basel III implementation assessments of Hong
Kong SAR and Mexico as well as follow-up
reports published by the Basel Committee
The Basel Committee on Banking Supervision
published reports assessing the implementation of the
Basel risk-based capital framework and the liquidity
coverage ratio (LCR) for Hong Kong SAR and Mexico.
These form part of a series of reports on Basel Committee members'
implementation of Basel standards under the Committee's Regulatory
Consistency Assessment Programme (RCAP).
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Inauguration of the new ECB premises
Speech by Mr Mario Draghi, President of the
European Central Bank, at the inauguration of the
new ECB premises, Frankfurt am Main, 18 March
2015.
“I am delighted to welcome you all today to the
inauguration of the new European Central Bank
headquarters.
Creating our new home is a project as old as the ECB itself. It began in 1998
with the search for a suitable site. In 2001 we found that site here at the
Grossmarkthalle.”
“The euro, our single currency, has become the most tangible symbol of
European integration - a piece of Europe accessible and valuable to each
and every one of us.
This building will inevitably become known as the "house of the euro".”
Celebrating Pi Day at the National
Cryptologic Museum
Saturday, 14 March 2015, 0900-1200
This once-in-a-lifetime event featured pi related
activities for the whole family, to find the diameter of a
head using pi; make a bead bracelet in pi order; hear the
story of "Sir Cumference and the Dragon of Pi;" and
much more.
Visitors could also tour the museum to learn all about
our cryptologic history.
As you know, pi to the tenth digit is 3.141592653, and by day/time that is
March 14, 2015 at 09:26:53 making this year very unique.
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Remarks at the University of Notre Dame,
Mendoza College of Business, Center for the
Study of Financial Regulation
Commissioner Michael S. Piwowar
Notre Dame, IN
“Today, I want to focus my remarks on the equities markets, and
specifically equity market structure.
Although it may be hard for some of you in this room to believe, in the 20
months since I began this job, some have suggested that I am a so-called
“market structure expert.”
While such comments are certainly flattering, I cannot accept the
compliment.”
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Regulators, Checklists and Navy SEALs: A
Collection of Thoughts for Future
Accountants
Jay D. Hanson, Board Member
Beta Alpha Psi, West Lafayette, IN
Good evening,
I am pleased to be here this evening to speak with the Beta Alpha Psi
members at Purdue University.
I always enjoy meeting with a promising group of young people preparing
for a career in the accounting profession.
I started my own career in accounting over 35 years ago as a public
accountant at a large accounting firm, and I have enjoyed the varied paths I
have been able to explore since that time.
For the past four years, I have been at the Public Company Accounting
Oversight Board, where I have experienced many things I could not have
imagined when I graduated from college.
Speaking of the PCAOB, before I go further, I must note that the views I
express today are my personal views and do not necessarily reflect the views
of the Board, any other Board member, or the staff of the PCAOB.
Most of you will start your careers in accounting by working for a public
accounting firm, as I did.
If you do, you may be faced with a choice of working in audit, tax or
consulting.
This will be an important choice to consider.
The fundamental role of an auditor is to serve the public interest and
independently report on whether a client's financial statements are fairly
presented, while accountants working in a firm's tax or advisory business
primarily serve the client's management and often take on advocacy roles.
Of course, some of you will go to work as accountants in businesses,
government or not for profit organizations billing customers, collecting
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cash, paying bills, reconciling bank accounts and preparing financial
statements.
Whatever role you play, accounting is an essential component of
monitoring any organization's performance, valued by operating managers,
CEO's, board members, investors, lenders and others.
Accounting information is so important that there are many checks and
controls intended to help the company, and the accountants, "get it right."
The most basic control in a company involves one person entering
accounting transactions and require that another person check that work
and document that a review occurred.
Other controls are designed to allow a knowledgeable person to review the
results for a group of transactions for a period of time, to assess whether the
results are reasonable, and to detect any material misstatements.
At the financial statement level, an investor or lender, who doesn't have the
ability to look directly at transactions or to determine whether controls
were followed, may require that an independent, objective third party
review the transactions and financial statements to provide a check on
management.
To ensure that such an independent review takes place on behalf of
investors in public companies, the federal securities laws in the United
States have long required that public companies engage independent
auditors to conduct audits of their financial statements and to issue
opinions on whether the financial statements are fairly presented in
accordance with the relevant accounting principles.
This sounds reasonable, but if a company is allowed to pick its own auditor
to provide this "check," and the company pays the auditor's fees, who
makes sure the auditor does their job effectively and independently?
Prior to 2002, the audit profession set its own standards for conducting
audits and imposed on itself a requirement that each audit firm hire a
"peer" firm to conduct a review of its work every three years.
Unfortunately, a number of significant accounting frauds in the 1990s and
early 2000's, which went undetected by large audit firms, demonstrated
that this self-regulation of the audit profession was not working.
Most of the students here are too young to remember these events, but
many people from your grandparents' generation had to rethink their
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retirement plans after companies unexpectedly went out of business and
many investments lost significant value.
The PCAOB was created by Congress as a direct result of these events,
through the passage of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley
Act"), to oversee the audits of public companies in order to protect investors
and the public interest by promoting informative, accurate, and
independent audit reports.
Because of the importance of the internal controls I mentioned earlier, the
Sarbanes-Oxley Act also required auditors to issue an opinion on the
effectiveness of the company's internal controls over financial reporting.
As a result, almost twelve years ago, the PCAOB opened its doors and began
taking over the role of setting standards for audits and reviewing the work
of firms (through inspections and enforcement), in order to provide an
independent check on the work of independent auditors of public
companies.
The PCAOB is led by a five member Board, each of whom is appointed by
the U.S. Securities and Exchange Commission ("SEC") to a five year term
(with a maximum of two terms permitted).
As mandated by the Sarbanes-Oxley Act, at any one time, two of the five
Board members must be Certified Public Accountants, and, currently, I am
one of these two.
The Board operates under the oversight of the SEC, which, in addition to
appointing Board members, must approve our budget and any rules and
standards issued by the Board.
The SEC also is empowered to hear appeals of our inspection
determinations and enforcement orders.
Under the Sarbanes-Oxley Act, the PCAOB has four main responsibilities:
1. Registration of public accounting firms that audit public companies or
broker-dealers;
2. Inspections of registered public accounting firms;
3. Setting of auditing standards for the audits of public companies and
broker-dealers; and
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4. Investigations and disciplinary proceedings in cases where auditors may
have violated certain provisions of the securities laws or applicable
standards or rules.
In order to achieve our mission, we have a staff of over 800 employees,
which work in in sixteen offices around the country.
The majority of our employees work in our core program areas in the
Division of Inspections and Registration, the Division of Enforcement and
Investigations or the Office of the Chief Auditor.
In addition to our administrative offices, we also have an Office of
International Affairs and an Office of Research and Analysis, both of which
provide important information and assistance to the Board and staff.
Most recently, we have established a Center for Economic Analysis,
intended to help us better understand the economic consequences of our
work and evaluate the economic impact of audits on the capital markets.
Currently, more than 2300 firms are registered with the Board, including
over 900 foreign firms from 85 jurisdictions.
The Board has conducted well over 2000 inspections of public company
audits, including inspections in 44 jurisdictions outside the United States.
After the Dodd-Frank Wall Street Reform and Consumer Protection Act
gave us authority in 2010 to inspect the auditors of brokers and dealers, we
commenced an interim program of broker-dealer auditor inspections.
We are evaluating the findings from the interim inspection program and
will consider the effects of our recently issued new broker-dealer audit
standards in determining the scope of a future permanent inspection
program.
In 2003, shortly after its inception, the PCAOB adopted the auditing
standards of the accounting profession in existence at that time, on an
interim basis.
Since then, the Board has issued 18 auditing standards — including, for
example, standards addressing audit documentation, internal controls,
audit planning, engagement quality review, risk assessment, audit
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committee communications and related parties — as well as two attestation
standards for audits of brokers and dealers.
We also have substantially amended a number of interim standards, such as
those addressing communications about control deficiencies, audit reports,
audit sampling, and substantive analytical procedures, among others.
Current projects include work on standards governing the supervision by a
lead audit firm of other auditors participating in the audit, the use by an
auditor of specialists, the auditor's responsibilities for going concern
opinions, and several others.
The fourth prong of the PCAOB's statutory mission is enforcement of
applicable federal laws, standards and rules.
The Board has publicly announced sanctions against many firms and
individuals, including revocations of firm registrations, orders barring or
suspending individuals from practicing before the Board, censures and, in
some cases, significant monetary penalties.
Our cases have involved Big Four firms as well as smaller firms and sole
practitioners and have been brought against firms in the U.S. and abroad.
In general, our cases have involved one or more of the following issues:
poor audit work, non-cooperation with PCAOB inspections or enforcement
(including submitting false information during inspections), independence
violations, and failure to comply with PCAOB rules requiring the filing of
firm annual reports and payment of annual registration fees.
In my experience, as a result of the PCAOB's work and the efforts and
resources expended by firms, we have seen improvements in the quality of
audits and the awareness of auditors of their unique and important role in
the capital markets.
Of course, there have been challenges for both the PCAOB and audit firms
in adjusting to this new regulatory world, but we are committed to working
with firms to continue to improve.
Early on during the PCAOB's existence, inspectors were seeing a lot of
problems with what I call basic "block and tackling" of auditing.
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While we still see problems in this area on occasion, the vast majority of our
inspectors' findings now are more complex and occur in difficult audit
areas.
Recently, frequent inspection observations have included findings in the
following financial statement areas:
-
Revenue;
-
Fair value and other estimates, particularly:
Business combinations and impairment of goodwill and other assets;
Investment valuation; and
Allowance for doubtful accounts/loans.
Our inspectors review the audit work on revenue in virtually every
engagement selected for inspection, which may explain why we have so
many findings.
It is, of course, one of the most important metrics in the financial
statements, so we believe it is an important area of focus.
The challenges continue in the areas of fair value and estimates.
These are complex areas, and generating accounting measurements based
on assumptions about the future presents inherent difficulties.
But some of the audit deficiencies we see are surprisingly basic mistakes.
This includes the auditor not testing the assumptions underlying a fair
value measurement, such as a reporting unit for a goodwill impairment test.
In other areas, however, such as the use of pricing sources to assist the
auditor in testing the fair value of hard to value securities, we have seen a
significant decline in the number of deficiencies.
Over time, I believe the focus on fair value measurements in accounting
program curriculum must increase, since these concepts are at least as
important as cost accounting, which virtually all programs still require.
I mentioned earlier the importance of internal controls. Because they are so
important, the PCAOB also has focused on reviewing auditors' controls
testing.
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This is still a relatively new area for auditors.
We continue to see a high rate of findings in this area, though the nature of
our findings is evolving and becoming more granular as auditors are
becoming more proficient at complying with the applicable standards
(including AS No. 5, issued by the Board in 2007).
I applaud the progress that has been made in this area, but it is apparent
that there is more work to be done to ensure consistent application.
When an auditor does not comply with all of the requirements of AS No. 5,
but assumes that the controls testing was sufficient and therefore reduces
the amount of substantive testing, the end result is a shortfall in the amount
of audit work necessary to support the auditor's opinion.
Underlying many of these findings, and others, are deficiencies or
weaknesses in the firm's systems of quality control.
While auditors are generally equipped to do good job, in terms of their
education and experience, and the resources provided by the firm to
conduct audits, we occasionally observe a break-down of sorts in the
systems that are intended to ensure that audit work is consistently at a high
level.
Some examples of deficiencies in quality control systems that we have
observed include problems with a firm's tone at the top — meaning that
firm leadership does not consistently demonstrate and communicate that it
values audit quality above client satisfaction or attracting new clients— lack
of professional skepticism by auditors, inadequate training or audit
guidance for staff, ineffective monitoring by the firm of its performance
over time, client acceptance and retention policies that lack rigor, and
several others systemic problems.
Because these types of problems contribute to deficiencies in audit
performance, one of the most effective ways for firms to improve audit
quality and avoid negative PCAOB inspection reports is for the firm to
remediate deficiencies in that quality control system.
The Sarbanes-Oxley Act provided an incentive to do just that, by requiring
firms to address quality control deficiencies identified by the Board within
twelve months of the date of the inspection report, or risk publication of any
deficiencies that are not timely remediated.
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As the Board observed early on in its existence, this requirement "rested on
the hypothesis that firms could be genuinely motivated by the prospect of
keeping the Board's quality control criticisms confidential."
In 2006, along with issuing a Board release describing the Board's process
for determinations regarding remediation, the Board issued a general
report, discussing its observations of the firms' initial implementation of
the remediation requirements.
Since then, the PCAOB and registered firms have gained nearly a decade of
additional experience with the remediation process.
With respect to the vast majority of quality control deficiencies, firms have
taken appropriate remedial steps, in some cases expending enormous
resources to re-vamp audit programs, increase expertise in certain areas,
provide better training, improve internal monitoring systems, among many
other helpful actions.
Nevertheless, the Board has made public some or all of the quality control
weaknesses of well over 150 firms, including some that provided no
response to the Board to describe their remedial efforts.
Of the largest six public accounting firms in the U.S. which are members of
global firm networks, five have been subject to publication by the Board of
one or more quality control deficiencies as a result of a Board
determination that the deficiencies were not timely remediated.
Of course, many positive developments are accompanied by potentially
negative, unintended consequences.
A variety of individuals have shared with me their view that audits today
have become very "checklist" oriented, perhaps as a result, in part, of efforts
to prevent future PCAOB inspection findings.
With an increase in checklists to complete, some fear that much of the
judgment and thinking has been removed from the audit and, as a result,
audit quality can suffer.
However, I don't believe that checklists can or should take the place of
thought and judgment, and I do not believe that audit firms intend them to
do so.
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Imagine a pilot of an airplane having the attitude that the extensive
preflight checks they complete are just a "compliance exercise" that does
not require careful attention or the exercise of judgment to go above and
beyond the list when something seems just a bit "off."
I would not want to fly on that plane.
Another area where checklists are becoming more common are operating
rooms in hospitals around the world.
Studies show that such checklists reduce errors and improve patient
outcomes.
But nobody would suggest that the checklists could take the place of the
surgeon paying careful attention during the surgical procedure and using
experience and judgment to protect the patient's best interests.
The bottom line is that checklists can be a great addition to help navigate
complex processes, but they should not take the place of judgment.
They are reminders of all the things you need to think about, but you still
need to think — about the various paths you can take, the potential
outcomes that may result, and, as an auditor, what would be in the best
interests of investors.
After all, you and those who came before you did not spend five years
studying, so that you can stop using your brain when you start your
professional career.
Finally, let me talk about some of the challenges you will inevitably face in
your career.
I always emphasize several key characteristics that I have observed in
successful professionals: communications skills, being prepared, being
organized, being proactive, and, perhaps most importantly, professional
skepticism and having the courage to stand up for yourself.
I am going to borrow from someone else's speech to discuss some of these
important characteristics in a little more detail:
Last May, Naval Admiral William F. McRaven, who was then commander of
U.S. Special Operations Command, delivered the commencement address
at the University of Texas at Austin. (He went on to accept the role of
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Chancellor of the University of Texas System after his retirement from the
Navy.)
Admiral McRaven's commencement address focused on "Ten Life Lessons"
and reflects his views on Navy SEAL training and his experiences of 37
years in the Navy.
I highly recommend you read this speech or watch the video.
I am not going to repeat his ten lessons but will pick a few to comment on in
the context of the accounting profession.
"If you want to change the world, start off by making your bed."
This is not something a college student wants to hear!
However, the point the Admiral makes is to start the day with a task
completed.
He notes that if you can't get the little things right, you will never get the big
things right.
To me, this reflects the importance of being organized, starting when you
get up, and pressing forward the entire day.
After all, accountants and auditors deal with a lot of little things that cannot
be ignored or glossed over lest they add up to a big problem.
"If you want to change the world, find someone to help you paddle."
The Admiral describes paddling a boat in the surf off the coast of San Diego
and the need for every crew member to coordinate to help the boat reach its
goal.
Starting a career in accounting or auditing is difficult.
You will need lots of on the job training, and you will need to learn to work
as part of a team.
I was very lucky to have incredible people that cared about me over the
years and helped me along.
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I returned that by trying to be a solid trainer and mentor for others that
came after me.
So pull your weight on the team, ask for help when you need it, and provide
assistance to others when you can.
"If you want to change the world, measure people by the size of their hearts,
not the size of their flippers."
This comment is about diversity in ethnicity, background, education, social
status, and in the case of the Admiral's SEAL training classmates, size.
My observations over the years in public accounting are consistent with his
— that none of these matter except the "will to succeed."
I know that the accounting profession can do a better job on the diversity
front, and many firms are working to increase the diversity of their staff.
At the PCAOB, we have significant diversity, which helps with everything
we do, including, for example, international inspections where language
skills and awareness of cultural differences are vital.
As you move forward in your careers, as Admiral McRaven advised, focus
not on superficial characteristics — your own or those of others — but base
your judgment on hard work and the desire to succeed.
"If you want to change the world, get over being a sugar cookie and keep
moving forward."
The sugar cookie reference is to the consequence of a less than perfect
uniform inspection: the SEAL candidate would have to take a fully clothed
trip into the surf, roll in the sand, and subsequently wear that same uniform
all day.
In public accounting, it can feel like your work papers are never good
enough.
A senior may ask you to rewrite something.
A manager will ask for even more clarification. It goes on and on.
Sometimes comments are substantive; other times the request may be as
silly as changing the font color or size to match a personal preference.
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Sometimes you will feel like you received a failing grade on every paper.
Over time, however, your auditing and writing skills will improve, and, soon
enough, you will be writing similar review notes for others (though
hopefully not the one about the fonts!).
So keeping going — much like the SEAL in the itchy uniform, you, too, will
get through the day.
"If you want to change the world, don't back down from the sharks" and "If
you want to change the world, you must do your very best in the darkest
moment."
I won't pretend that accountants face nearly the darkness that members of
the armed forces face every single day. But there are time pressures
demanding supervisors and other challenging aspects to being a young
public accountant.
There are a lot of sharks in the world, and sometimes a member of your
client's management team may act like one.
Deadlines for public company press releases and filing are rarely missed, no
matter the challenges involved.
The push to "get it done" is extreme. Diligent planning, staying organized,
and proactively addressing problems can help avoid a last minute crisis.
But in the final push, you have to bring your best work — most importantly
by never compromising your professional skepticism and the courage to do
what is right.
Admiral McRaven concludes with these words:
Start each day with a task completed.
Find someone to help you through life.
Respect everyone.
Know that life is not fair and that you will fail often, but if you take some
risks, step up when the times are toughest, face down the bullies, lift up the
downtrodden and never, ever give up—if you do these things, then next
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generation and the generations that follow will live in a world far better
than the one we have today and—what started here will indeed have
changed the world—for the better.
I will never be able to top these words, but I will pass them on often. I thank
Admiral McRaven for his service to our country and these fine words to live
by.
Thank you for joining me this evening.
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How can prudential regulation foster
growth?
Speech by Ms Sabine Lautenschläger, Member
of the Executive Board of the European Central
Bank and Vice-Chair of the Supervisory Board
of the Single Supervisory Mechanism, at the
Frankfurt Finance Summit, Frankfurt am Main
Supervisors can contribute to sustainable
economic growth by ensuring that supervised
entities are resilient to plausible shocks, properly managed, adequately
capitalised and subject to an efficient risk management and the right
incentives.
The European Single Supervisory Mechanism takes a medium to long-term
perspective on this, resisting those who argue for short-term relief.
The SSM ensures that banks can deliver in their tasks in all phases of the
economic cycle and thus are able to provide the economy with the financial
services that corporations, smaller firms and citizens need.
***
It is my pleasure to open this dinner with a question that may seem quite
straightforward, but whose answer is far from intuitive, especially from the
perspective of a supervisor: "How can prudential regulation foster growth?"
I must admit that when I first saw the topic of this short speech I was
tempted to turn this into a brainstorming session.
I am sure that many of you have innovative ideas on how to foster growth
by means of prudential regulation and supervisory action.
Some might suggest restraint on the side of regulators and supervisors as a
way of fostering growth - and they may be right regarding some of the many
topics that were regulated over the last seven years.
But if you now expect me to provide comfort with a regulatory break or even
promise supervisory leniency, I am afraid you are in for a disappointment.
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The financial crisis has shown that there is little more damaging for
sustainable growth than a malfunctioning banking sector.
That is why - after a long period of deregulation - governments around the
world decided to strengthen regulation and supervision.
The ultimate objective of these reforms has been the same since the 1930s:
regulators and supervisors have to ensure that the banking sector is
resilient and provides the economy and society at large with its key services,
even under severe stress.
As a supervisor, our most valuable contribution to economic growth is to do
our job - by implementing regulation consistently, by closely monitoring
supervised institutions in a forward-looking, risk-based and proportionate
way and by taking timely and determined action when needed.
The SSM has the responsibility and privilege to go a step further.
By harmonising supervisory practices, we will contribute to a level-playing
field which will eventually also foster growth.
To be more concrete, I would like to draw your attention to two important
issues with implications for growth which both also reflect the unique
features of the SSM.
The first one is the Supervisory Review and Evaluation Process (SREP),
which gives us the instrument to tailor supervisory requirements beyond
the minimum capital requirements set by the Basel Accord.
We take into account the banks specific business risks, but also include
governance and internal controls.
The second one is the harmonisation of supervisory practices to the highest
standards, through the consistent and rigorous exercise of options and
discretions formally left to national supervisors.
Both topics, SREP and options and discretions, relate, among other things,
to "more capital with higher quality".
Let me first respond to concerns about some of our SREP decisions.
Some critics argue that setting capital requirements above the regulatory
minimum hampers the economic recovery in Europe.
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You will not be surprised that I do not share these concerns.
On the contrary, I am of the firm view that the time for muddling through is
over.
Generally setting capital requirements at the minimum might have an effect
on short-term growth (though this is highly questionable), but it would
come at the expense of more problems in the future if the bank concerned
has a specific need for capital.
I think we can all agree that we need banks that are able to permanently
fulfil their role in good times as well as bad.
That is why we have to start working towards that now by using the SREP to
set capital requirements as appropriate for the individual banks' risk profile
and governance.
I appear to be in good company with this view: there seems to be a
consensus in the academic literature that an increase in regulatory capital
requirements has a positive impact on lending to the real economy in the
long term, while loan reduction can occur in the short term.
For a start, the vast majority of banks have capital buffers above the
thresholds implied by the SREP decisions, which in those cases means that
an increase in capital requirements would actually have little or no effect on
the banks' credit supply.
In the event of an actual deleveraging by a bank as a result of a SREP
decision, lending activities would often not be hit as it would be logical for
the bank to first reduce its non-core business.
And even if there were a reduction in credit supply by specific banks, this
could only have a consequence on the real economy if no off-set happened
elsewhere in the financial system.
Finally, there would need to be an assumption that no relief in the banks'
funding costs would occur as a result of the improvement of the capital ratio
imposed by the SREP decisions.
Therefore, I would call for caution when making a direct link between SREP
decisions and consequences on the real economy.
But the SREP is not only about capital, it is much more.
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The overall efficiency in operations and in credit allocation, as well as the
stability and resilience of the banking sector do not depend solely on the
level and quality of capital.
Capital should actually be a bank's last line of defence, and the supervisory
approach we believe in implies that we are not engaged in a simple
box-ticking exercise, whereby internal processes and conduct features can
be ignored as long as a bank holds enough capital.
On the contrary, we have decided to use the SREP exercise to perform an
acute forward-looking review and challenge top managers in all aspects of
the banks' operations.
This goes beyond the assessment of traditional risks.
The SREP allows supervisors to draw conclusions on the banks' internal
governance, risk management practices, incentive systems, effective data
aggregation, as well as the general risk appetite of the institution and how it
matches its business model.
This can result in the supervisor potentially requiring the bank to hold
additional capital, but this outcome is only one of the supervisory tools
available.
As the European banking system faces a challenging mix of low growth,
high volumes of non-performing loans, a low interest rate environment and
intense competition, the comprehensive SREP process is of paramount
importance.
Banks might embark on dangerous business strategies or reduce costs by
reducing staff for risk management.
Only by taking a holistic view of the bank can the supervisor counter the
build-up of risks on all levels and weaknesses in governance and internal
controls with adequate capital surcharges.
Being able to apply these principles and actions in a single and consistent
manner for all SREP decisions is a major benefit of the SSM, both for
supervisors and for banks themselves, which are treated on an equal footing
based on the single methodology applied across the board.
This approach, consisting in identifying best practices and then
harmonising the performance of supervision accordingly, is also reflected
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in the work we are currently undertaking at the SSM on regulatory options
and national discretions.
Up until now, Member States in the euro area, banks and supervisors have
to work with more than 150 different options and national discretions in the
single rulebook.
These options and national discretions are often a legacy resulting from
different market structures and legal environments.
Many of them have material effects on the level of prudence of the
framework and on the comparability of capital ratios; they also add an
additional layer of complexity as well as a source of regulatory arbitrage, of
risk to the financial sector and of competitive disadvantage for banks
established in Member States that have chosen the most virtuous standard.
Let me take one example related to the transitional arrangements in the
definition of capital.
The various phase-in arrangements of the CRR capital definitions within
the SSM account for an overall €126 billion gain compared to the
"fully-fledged" definition.
This amount is unequally shared across national banking systems as clearly
shown in the comprehensive assessment report published last year.
It is up to the SSM to use its power for exercising options and national
discretion wisely.
We aim to improve the comparability of capital ratios. In the medium to
long run, this will permanently increase the resilience and service capacity
of banks.
It is up to the SSM to use its power for exercising options and national
discretion wisely.
We aim to improve the comparability of capital ratios and create
transparency by providing reliable information to citizens and market
participants.
In the medium to long run, this will permanently increase the resilience and
service capacity of banks.
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Of course, harmonisation cannot be a goal in its own right. Exactly the same
is true for national specificities: if national specificities contribute to a more
stable banking system, the SSM will be eager to preserve or even promote
them.
But if national characteristics are only the reflection of unquestioned
traditions and regulatory capture, they should be eradicated.
As with the SREP decisions, we expect positive outcomes in terms of
prudence, consistency and stability of the framework to outweigh by far the
adjustment costs that each national banking system will face by converging
to the high standards.
Let me conclude, as dinner is awaiting us.
While banking is a complex business, and as such it cannot be naively
regulated or supervised, there is of course always room for improvement.
Therefore, you will be pleased to hear that simplicity and comparability of
prudential standards have become a top priority for the Basel Committee
on Banking Supervision, and that regulators are now giving greater
attention to formerly disregarded parts of EBA standards called "impact
assessments".
As member of the Basel Committee, I very much welcome this
development.
That being said, I am convinced that supervisors can contribute to
sustainable growth by ensuring that supervised entities are resilient to
plausible shocks, properly managed, adequately capitalised and subject to
an efficient risk management and the right incentives.
We as the SSM take a medium to long-term perspective on this, while
resisting those who argue for short-term relief.
Our role, in short, is to ensure that banks can deliver in their tasks in all
phases of the economic cycle and thus are able to provide the economy with
the financial services that corporations, smaller firms and citizens need.
Achieving this ambitious objective will certainly contribute to the economic
growth that Europe is craving for.
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President's address at the 16th ECB and its
Watchers Conference
Speech by Mr Mario Draghi, President of the
European Central Bank, at the conference "The ECB
and Its Watchers XVI", Frankfurt am Main
Summary
In January, the ECB decided to expand its asset purchase programme to
include government bonds after it became clear that there was a need for
more monetary stimulus.
Asset purchases are unconventional, but not unorthodox, and they have
been part of the ECB's toolkit from the start.
By deploying this tool, the ECB underlined its ability and determination to
stabilise euro area inflation in line with its objective.
The impact of the programme and the ECB's previous monetary policy
measures is visible: Bank lending rates to companies started to decline in
the third quarter of last year, market-based measures of inflation
expectations have reacted positively to the ECB's balance sheet expansion
over recent months, and euro area long-term sovereign yields have fallen in spite of the renewed crisis in Greece.
This suggests that the asset purchase programme may be shielding other
euro area countries from contagion, which also helps the ECB achieve its
monetary policy goals across the euro area.
The euro area economy grew more than expected in the fourth quarter and
unemployment fell to its lowest level since August 2012 in January.
While this cannot exclusively be attributed to the ECB's monetary policy, it
certainly supports the recovery.
Even though inflation is expected to remain very low or negative in the
months ahead mainly due to the sharp drop in oil prices, it is expected to
move closer the ECB's policy target over the coming years to reach 1.8 per
cent in 2017 - conditional on the full implementation of all policy measures.
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The beneficial impact of the ECB's asset purchases on financing conditions
will increase the benefits of governments' structural reforms, rather than
reducing incentives for reforms.
Firms will be encouraged to increase investment, bringing forward the
economic recovery.
***
Ladies and Gentlemen,
Since the last Watchers' conference in March 2014, we have reached deeper
in our monetary policy tool box.
The means have changed quite substantially, as dictated by circumstances,
but the end has not.
To be able to deliver on our medium term price stability mandate, we
needed to adapt and expand our monetary policy tools.
I would like to open this conference by elaborating on what has changed,
how it has changed, and how this helps us to fulfil our mandate.
Reaching deeper into the monetary policy toolbox
At the time of the last Watchers' conference policy rates were already
moving towards zero and we had reached a point where there was little
room for manoeuvre with the standard instrument of monetary policy.
We did eventually reach the effective lower bound later in the year by
lowering incrementally the corridor of policy rates in June and September.
When a central bank's ability to steer the overnight rate is limited, it can
still alter its monetary stance by means of directly influencing expectations.
This is the context in which the ECB introduced forward guidance in 2013.
Our forward guidance was effective in flattening the money market curve
and decoupling it from the curve in the United States.
But its power becomes more limited, as the horizon over which the policy
rate is intended to be at the effective lower bound extends beyond the
forecast horizon.
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Moreover, forward guidance by the ECB was not and could not, in Paul
Krugman's words, "credibly promise to be irresponsible".
What this means is that when the need for additional monetary stimulus
arose, the ECB could no longer rely solely on acting in the money market,
counting on transmission from the money market to other market
segments, and from those to the real economy.
Like other major central banks, we therefore had to intervene directly in
markets beyond the money market to have a more direct impact on the
various channels of monetary policy transmission.
And the way to do that was to purchase assets in those other markets.
Unconstrained monetary policy is key
Asset purchases are nothing new.
They have been available and have been routinely used by central banks
ever since these institutions came into existence, and that was long before
the crisis started.
Incidentally, asset purchases have formed part of the ECB's toolkit from the
start: outright purchases of marketable instruments - which include
government bonds - have always been listed in our statute as part of our
monetary policy toolbox.
And the legitimacy of using public sector bond purchases in the pursuit of
medium-term price stability was unanimously confirmed by the Governing
Council on 22 January.
Asset purchases are unconventional, but they are not unorthodox. They are
in fact eminently orthodox.
And they are in a central bank's toolbox for a reason.
Independence is essential for the central bank's credibility. But equally
essential is that the central bank has the means, i.e. the policy instruments,
to achieve its mandate.
Together they allow the central bank to achieve price stability, which in turn
boosts its credibility.
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Our decision in September to make use of asset purchases had significant
effects.
But still, when we announced the purchase of asset-backed securities
(ABSs) and covered bonds, there were some in the market place who
doubted our commitment and the effectiveness of our monetary policy.
They thought we might be hampered either by there being a limited
availability of assets that we could purchase in the market or by legal or
political obstacles to our ability to expand the range of assets, should it
become necessary.
If we were so constrained, that would affect our credibility because our
ability to anchor expectations relies in part on the fact that we are free to set
the appropriate monetary stance.
In this context, the decisions we took in January to expand the range of our
asset purchases must have assuaged those concerns.
We can deploy - and we are deploying - monetary policy in a way that can and will - stabilise inflation in line with our objective.
How the expanded asset purchase programme is working its way
into the real economy
As its name indicates - the expanded asset purchase programme is just an
extension of the programme that we announced in September as part of a
more comprehensive easing package.
This package has been effective in improving the pass-through from
liquidity injections into private sector borrowing costs: bank lending rates
to non-financial corporations started to decline in the third quarter of last
year, coinciding with the first targeted long-term refinancing operation
(TLTRO) and our announcement to purchase ABSs and covered bonds, and
also following the repair of banks' balance sheets during the comprehensive
assessment.
Furthermore, model-based estimates indicate that - controlling for other
developments - market-based measures of inflation expectations have
reacted positively to the progressive expansion of our balance sheet over the
last few months.
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There is thus good reason to believe that as our balance sheet grows more
substantially under the expanded asset purchase programme, it will
support a rebound of these measures.
Second, our policy announcement was largely anticipated. On 1 January
2015, 60% of surveyed experts attached a 65% or higher probability that we
would announce a public sector securities purchase programme at our
January meeting.
And, according to various surveys, expectations were already quite high in
autumn last year.
These anticipation effects show up in the financial data.
According to estimates, the impact of the asset purchase programme has
accounted for most of the fall in euro area long-term sovereign yields since
August last year.
The same applies for movements in other financial markets metrics, such as
the fall in long-term corporate bond yields of non-financial corporations.
Beyond anticipation effects, the announcement of the expanded
programme of asset purchases itself also led to substantial further falls in
longer-term sovereign yields.
For instance, from just before our announcement on 22 January to the
close of business the day after, German 20-year maturity yields fell by
almost 25 basis points and Italian 20-year maturity yields fell by almost 35
basis points.
We also saw a further fall in the sovereign yields of Portugal and other
formerly distressed countries - in spite of the renewed Greek crisis.
This suggests that the asset purchase programme may be shielding other
euro area countries from contagion, which also helps us achieve our
monetary policy goals across the euro area.
The reductions in sovereign yields seem to have passed through into other
fixed-income assets, as well as to equities and the exchange rate.
Yields on covered bonds and corporate bonds declined in tandem with
longer-term sovereign yields - even though corporate bonds are not
included in our purchase programme.
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Such spillover effects are associated with portfolio rebalancing, which is one
of the channels through which the asset purchase programme reaches the
real economy: our purchases reduce returns on safer assets.
This encourages investors to shift to riskier, higher yielding assets.
Pension funds, banks and other market participants that we buy securities
from are likely to substitute these for other long-term assets, thereby
eventually pushing up prices more broadly.
We are aware that our measures may entail some financial stability risks.
But currently these risks are contained.
And should they emerge, macroprudential policy is best suited to address
them.
Experience with large-scale asset purchase programmes in other
jurisdictions shows that the portfolio balance channel works.
For instance, model-based estimates show that as a consequence of the
Bank of England's quantitative easing programme, insurance companies
and pension funds invested less in gilts and more in corporate bonds, 1
leading to price increases of both investment grade and non-investment
grade corporate bonds.
Drawing inferences from the experience in other jurisdictions is certainly
helpful to gauge the potential impact of our own programme.
Much has been said about the different conditions - meaning much lower
bond yields - under which we are starting our expanded asset purchase
programme from those under which other central banks did so.
It is claimed that this reduces the impact on bond yields.
But, in fact if one standardises the size of the various programmes and takes
into account anticipation effects, the overall impact of our programme on
bond yields was comparable in size to that observed in other jurisdictions
such as the US and the UK.
Conditions also differ because financial structures differ. In the euro area,
corporate debt financing mainly takes place via banks, as opposed to capital
markets in the United States.
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There is, however, no reason, once the transmission channel is not
impaired by banks' poor balance sheets, why this difference should impede
the effectiveness of a broad-based asset purchase programme that works
through a multitude of channels.
The programmes of both the Bank of England and the Bank of Japan were
effective and the respective economies are almost as bank-based as the euro
area.
One criticism is that we should have implemented our asset purchase
programme much earlier.
But it is not that we have not been acting last year. In a speech in
Amsterdam in April last year I laid out three contingencies that would
warrant a monetary policy reaction.
These were, first, an unwarranted tightening of monetary policy stance (e.g.
from developments in short-term money markets) that could be tackled
through more conventional measures.
Second, a further impairment in the transmission of our stance, in
particular via the bank lending channel, for which a targeted LTRO or an
ABS purchase programme might be the right response.
And third, a worsening of the medium-term outlook for inflation, which
would warrant a more broad-based asset purchase programme.
As these contingencies materialised we acted, first in June with the
announcement of the TLTRO and ABS purchase programme.
Then, as medium to long-term inflation expectations started to drift
downward in the summer and the risks of a too prolonged period of low
inflation were rising, we broadened our asset purchase programme with
covered bonds in September and public sector securities last January.
Summing up, market reactions both before and after our announcement, as
well as experience in other jurisdictions show that the asset purchase
programme can work.
What is the evidence that the easing of financial conditions is finally
starting to affect the real economy?
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The expanded asset purchase programme and the outlook for
growth and inflation
Developments are pointing in the right direction.
The so-called surprise index that compares actual macroeconomic data
with consensus estimates of market analysts shows that on average the
latest news is positive.
The slowdown in growth has reversed.
Euro area real GDP rose by 0.3% quarter on quarter in the last quarter of
2014, which is somewhat higher than previously expected.
Survey evidence points to further improvements in economic activity at the
beginning of this year so that the economic recovery should gradually
broaden and strengthen.
And in January, the euro area unemployment rate dropped to the lowest
level observed since August 2012.
Of course, these improvements cannot and should not solely be attributed
to our monetary easing.
But our monetary policy is certainly supporting the recovery.
This is also reflected in the ECB staff macroeconomic projections that we
published last week.
In those projections, expectations for real GDP have been revised upwards,
both for 2015 and 2016, relative to the previous exercise.
These upward revisions are mainly driven by the favourable impact of lower
oil prices, the weaker effective exchange rate of the euro - and the impact of
our recent monetary policy measures.
The latter have had a very substantial impact on what we call
"market-based technical financial assumptions", such as interest rates,
exchange rates and stock prices, with the effect being especially large on
long-term interest rates.
Annual HICP inflation, in turn, is expected to remain very low or negative
in the months ahead and to start increasing gradually later this year.
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The ECB staff projections for inflation this year have been revised
downwards to 0.0%. This mainly reflects the sharp drop in oil prices at the
end of last year.
But there is good reason to believe that the effect of this shock will not
extend beyond 2015, in part because our monetary policy decisions have
significantly decreased the risk of second-round effects.
Accordingly, the inflation projection for 2016 has been revised slightly
upwards to 1.5%; and for 2017 inflation is expected to be 1.8%.
This expected pick-up in inflation is supported by the favourable impact of
our recent monetary policy measures on aggregate demand, the impact of
the lower euro exchange rate and the assumption of somewhat higher oil
prices in the years ahead.
The ECB staff projections fully incorporate the estimated impact of our
policy measures.
They are thus conditional on the full implementation of all the announced
measures.
And this is indeed what we have started doing last Monday.
Conclusion
Let me conclude. Our recent monetary policy measures are a valid and
effective tool to bring inflation closer to our policy goal.
They can support a faster and more sustained recovery.
This will especially be the case if they fall on fertile ground.
Governments can create a more investment-friendly environment by
swiftly, credibly and effectively implementing structural reforms.
The beneficial impact of our asset purchases on financing conditions, rather
than reducing the incentives for reforms, will actually increase the benefits
of such reforms, as firms will be encouraged to increase investment,
bringing forward the economic recovery.
Effective, price-stability oriented monetary policy and structural reforms
work hand in hand.
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DARPA “BRANDEIS” program for online
privacy and security
Effort seeks to bolster ability to protect vital networks
and sensitive data
DARPA announced plans to research and develop tools
for online privacy, one of the most vexing problems
facing the connected world as devices and data
proliferate beyond a capacity to be managed
responsibly.
Named for former Supreme Court Justice Louis
Brandeis, who while a student at Harvard law school
co-developed the concept of a “right to privacy” in a
seminal article under that title, the new program seeks
to explore how users can understand, interact
with and control data in their systems and in
cyberspace through the expression of simple
intentions that reflect purpose, acceptable risk
and intended benefits such as "only share
photos with approved family and friends.”
The right to privacy, as Brandeis argued in 1890, is a consequence of
understanding that harm comes in more ways than just the physical.
Brandeis was reacting to the ability of the “instantaneous camera” to record
personal information in new ways.
Since then, the ability of technology to collect and share information has far
exceeded judicial and social expectations.
The goal of DARPA’s newly launched Brandeis program is to enable
information systems that would allow individuals, enterprises and U.S.
government agencies to keep personal and/or proprietary information
private.
“Democracy and innovation depend on creativity and the open exchange of
diverse ideas, but fear of a loss of privacy can stifle those processes,” said
Dr. John Launchbury, DARPA program manager.
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“We aim to develop methods that can help protect private information
without having to impose cumbersome protective mechanisms that
ultimately deplete the larger value of the information at hand.”
Existing methods for protecting private information fall broadly into two
categories: filtering the release of data at the source, or trusting the user of
the data to provide diligent protection.
Filtering data at the source, such as by removing a person’s name or
identity from a data set or record, is increasingly inadequate because of
improvements in algorithms that can cross-correlate redacted data with
public information to re-identify the individual.
According to research conducted by Dr. Latanya Sweeney at Carnegie
Mellon University, birthdate, zip code and gender are sufficient to identify
87% of Americans by name.
On the other side of the equation, trusting an aggregator and other data
recipients to diligently protect their store of data is also difficult.
In the past few months alone, as many as 80 million social security
numbers were stolen from a health insurer, terabytes of sensitive corporate
data (including personnel records) were exfiltrated from a major movie
studio and many personal images were illegitimately downloaded from
cloud services.
“Currently, most consumers do not have effective mechanisms to protect
their own data, and the people with whom we share data are often not
effective at providing adequate protection,” said Launchbury.
“The goal of the Brandeis program is to break the tension between
maintaining privacy and being able to tap into the huge value of data.
Rather than having to balance these public goods, Brandeis aims to build a
third option, enabling safe and predictable sharing of data while reliably
preserving privacy.”
The potential impact of the Brandeis program is significant.
Assured data privacy can open the doors to personalized medicine by
discovering, for example, hidden correlations between genetic information
and the relative effectiveness of different therapies; smarter and more
efficient cities where buildings, energy consumption and traffic controls are
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all optimized minute by minute; crowdsourced collections of publicly useful
data about the environment, weather and emergency situations; and
fine-grained Internet awareness and protection where every company and
device instantly shares network and cyber-attack data.
Without strong privacy controls, none of these possibilities could come to
full fruition.
The Brandeis program is structured as a four-and-a-half year effort, split
into three 18-month phases.
Each phase will result in the demonstration of experimental systems that
show privacy technologies at work.
Background
Privacy is critical to a free society. Democracy and free enterprise both
depend on creativity, non-conformism and free interchange of diverse
ideas.
The threat of persistent observation has a chilling effect on both, promoting
conformance and inhibiting personal development or risky innovation.
The right to privacy, as Louis Brandeis expounded in 1890, is a
consequence of understanding that harm comes in more ways than just the
physical.
He was reacting to the ability of the new “instantaneous camera” to record
personal information in new ways.
Since then, the ability of technology to collect and share information has
grown beyond all expectation.
What we’ve discovered as a society is that this is both a good and a bad
thing.
The ability to analyze large amounts of aggregated personal data can help
businesses optimize online commerce, medical workers address public
health issues, and governments interrupt terrorist activities.
However, numerous recent incidents involving the disclosure of data have
heightened society’s awareness of the vulnerability of private information
within cyberspace.
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Moreover, there is so much data that it is currently infeasible for
individuals or enterprises to control it in a meaningful way with the
information technologies available today.
The White House has made cybersecurity a priority and has launched
numerous initiatives to enable the safe and effective sharing of information
(especially information related to cyber threats) to increase the nation’s
ability to protect itself and to thwart any adversary’s ability to shut down
networks, steal trade secrets, or otherwise invade privacy.
Finally, U.S. national security increasingly requires mutually sharing
information with coalition partners in order to collective benefits of
regional security.
Even at the unclassified level, such mutual sharing will require strong
assurance that shared information is only used as intended.
The Brandeis program seeks to develop the technical means to protect the
private and proprietary information of individuals and enterprises.
Some of the parallels between individual privacy and enterprise privacy are
outlined in the following table.
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Currently, the predominant methods for protecting private information fall
broadly into two categories: filtering the release of data at the source, or
trusting the user of the data to provide diligent protection.
Both have serious challenges.
Filtering data at source is problematic. For example, redacting specific
elements of personally identifying information is fragile at best.
Apparently innocuous information sets can often be cross-correlated with
public information to undo the redaction, and so re-identify the individual.
For example, it has been estimated that birthdate, zip code and gender are
sufficient to identify 87% of Americans by name.
On the other side of the equation, trusting an aggregator and other data
recipients to diligently protect their store of data is also problematic.
There have been numerous examples within the last year of how this has
failed.
For example, as many as 80 million social security numbers may have been
stolen from a health insurer, terabytes of sensitive corporate data
(including personnel records) were exfiltrated from a movie studio, and
many highly personal images were illegitimately downloaded from cloud
services.
Currently, we do not have effective mechanisms to protect data ourselves,
and the people with whom we share data are often not effective at providing
adequate protection.
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Program Vision and Goal
The vision of the Brandeis program is to break the tension between
(a)
maintaining privacy and
(b)
being able to tap into the huge value of data.
Rather than having to balance between them, Brandeis aims to build a third
option, enabling safe and predictable sharing of data in which privacy is
preserved.
Specifically, Brandeis will develop tools and techniques that enable us to
build systems in which private data may be used only for its intended
purpose and no other.
The potential for impact is dramatic.
Assured data privacy can open the doors to personal medicine (leveraging
cross-linked genotype/phenotype data), effective smart cities (where
buildings, energy use, and traffic controls are all optimized minute by
minute), detailed global data (where every car is gathering data on the
environment, weather, emergency situations, etc.), and fine grained
internet awareness (where every company and device shares network and
cyber-attack data).
Without strong privacy controls, every one of these possibilities would face
systematic opposition.
Program Description
The goal of the Brandeis program is to develop tools and techniques that
enable systems to be built in which private data may be technologically
protected so that it can only be used for its intended purpose and no other.
It seeks to restructure our relationship with data by shifting the
mechanisms for data protection to the data owner rather than the data user.
The primary focus of the Brandeis program is to protect data that is
knowingly provided to a third party, as opposed to data collected as a
byproduct of interacting with the network or a system.
The program has four technical areas (TAs):
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TA1. Privacy-preserving Computation
TA2. Human Data Interaction (HDI)
TA3. Experimental Systems
TA4. Metrics and Analysis
Performers in all four of the TAs will be required work cooperatively in the
context of tightly coupled collaborative research teams created under the
general oversight of the Government.
Each collaborative research team will be centered around one of the TA3
Experimental Systems and may contain multiple TA1, TA2, and TA4
performers.
Performers in TA1 and TA2 will be required to tune their research activities
to support the needs of the experimental systems being developed by the
TA3 performer on their collaborative research team.
Similarly, performers in TA4 will use the TA3 experimental systems being
developed within their team as a test bed to exercise their metrics and
analysis tools.
In turn, TA3 performers will tune their plans for their experimental systems
to optimize the research opportunities for the TA1, TA2, and TA4
performers to the extent that such flexibility makes sense in the context of
the systems being built.
Proposers may submit proposals for any or all of the technical areas, and
multiple awards are envisioned in each TA.
However, each proposal may only address a single technical area.
This is being done in an effort to maximize the flexibility the Government
has in creating collaborative research teams that hold the greatest promise
for breakthrough approaches.
Because no TA will succeed on its own, proposals will include a
Collaborative Research Team Concept section that describes how the work
would fit within the context of potential collaborative research teams (see
Section IV.B.a.v).
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This section provides the opportunity to outline the dependencies between
the work proposed and work in other technical areas.
The Collaborative Research Team Concept section should describe:
a)
The working assumptions about features or capabilities their
proposal requires from any of the other TAs; and
b)
Other additional features or capabilities that may be accommodated
within the scope of their proposed approach.
The Brandeis program is structured as a 4.5-year effort, split into three
18-month phases.
Each phase will result in the demonstration of experimental systems that
show privacy technologies at work.
As the Brandeis program advances through its three phases, the breadth
and completeness of the experimental systems will grow.
In order to promote collaborative research and sharing of results across the
entire Brandeis program, no programmatic down- select is anticipated,
though the Government reserves the right to make funding changes
throughout the life of the program as it sees fit.
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Revision of the FINMA
Anti-Money Laundering
Ordinance
The Swiss Financial Market Supervisory Authority FINMA has opened a
consultation on the draft revised version of the FINMA Anti-Money
Laundering Ordinance.
The revised ordinance reflects both the revised Anti-Money Laundering Act
of 12 December 2014 and the revised Financial Action Task Force
recommendations.
The revised ordinance also includes insights gained from supervisory
practice and recent market developments.
The deadline for submitting comments on the draft ordinance is 7 April
2015.
The FINMA Anti-Money Laundering Ordinance (AMLO-FINMA) has been
in force in its current form since 1 January 2011.
The Financial Action Task Force (FATF) recommendations were partially
revised in 2012.
They represent the internationally recognised standards on combating
money laundering and the financing of terrorism.
The Federal Department of Finance (FDF) then drafted a legislative
proposal to implement the revised FATF recommendations.
The revised Anti-Money Laundering Act (AMLA) was passed by Parliament
on 12 December 2014.
A subsequent revision of the AMLO-FINMA was therefore necessary.
The current revision of the FINMA Anti-Money Laundering Ordinance
takes account of both the revised FATF recommendations and the revised
Anti-Money Laundering Act, and sets out the regulations contained in both
pieces of legislation.
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The revised ordinance also includes insights gained from supervisory
practice and recent market developments; in particular, it also provides for
relaxation of due diligence requirements.
Some examples of the material adjustments to the draft ordinance are:
The concept of "controller”: this newly introduced concept is directed at all
(directly supervised) financial intermediaries.
It serves to consistently determine the natural persons behind operationally
active legal entities and partnerships.
Special regulations for CIS institutions: The new regulations are directed at
fund management companies, CIS investment companies and CIS asset
managers.
CIS institutions must identify the subscriber of fund units and the
beneficial owner.
Where certain prerequisites are met, a relaxation of due diligence
requirements is provided for.
New payment methods: The revised AMLO-FINMA now governs the
prerequisites under which relaxation of due diligence requirements is
allowed for payment service providers offering cashless payment
transactions.
Reporting requirements: A new innovation under the revised AMLA is that
despite reports to the Money Laundering Report Office (MROS), client
instructions must be executed by financial intermediaries (assets are not
frozen immediately).
A new provision sets out that significant assets may only be withdrawn in a
form which enables prosecuting authorities to follow the trail
("paper-trail").
The deadline for submitting comments on the draft ordinance is 7 April
2015.
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Critique of the financial crisis decisions of
end-September 2008 - my views
Introductory statement by Mr Patrick Honohan,
Governor of the Central Bank of Ireland, at the
Oireachtas Banking Inquiry, Dublin
In my letter of February 12, I sought to clarify parts of my evidence to the
Inquiry on January 15.
I have prepared these short introductory remarks on the presumption that
the Inquiry has invited me back on this occasion to amplify my views on the
alternative courses of action that might have been taken by the Government
at the end of September 2008.
Perhaps I should recall explicitly that I myself had no involvement in the
guarantee decision.
So my views are based on what I learnt from preparing my May 2010
Report on Regulatory and Financial Stability Policy, as well as on many
conversations with other experts and on my general knowledge of banking
crises in other countries.
Critique of the decisions of end-September 2008
There are several features of the decisions at end September that can be
criticised even allowing for the limited information then available to the
decision makers.
First, the guaranteeing of some of the subordinated debt.
Providing an explicit guarantee to subordinated debt holders is not only
potentially costly to the State but undermines the rationale for allowing
banks to meet part of their regulatory capital with subordinated debt.
This was a definite design flaw.
True, thanks to steps subsequently taken, the payout to subordinated debt
holders of Anglo in the end was a small proportion of the total fiscal cost;
however, they were not negligible.
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Second, guaranteeing existing outstanding debt (senior bonds and term
deposits).
This was not necessary to underpin the banks' continuing access to funds.
Nor did the government guarantees introduced by other countries in 2008
offer any significant backward looking protection in this way.
It is true that imposing losses on such bondholders would have had a
damaging reputational effect on Ireland as a whole, as well as impacting
local holders of such bonds; but that is a different question.
The decision to impose such losses could not have been lightly taken; but
offering a pre-emptive guarantee on already outstanding ("old") debt ahead
of a full assessment of what it might cost was essentially gratuitous.
Furthermore, because much of this debt entitled the holders to immediate
accelerated repayment in "an event of default", the Government were
effectively precluded from liquidating or extensively restructuring the
guaranteed institutions because they would have to repay the guaranteed
debt forthwith (which they would have been unable to do).
This effectively postponed drastic restructuring action until the end of the
guarantee period, by which time the Government's entry into the EU-IMF
programme was imminent.
Third, failure to consult. The Irish decision to provide a blanket guarantee,
without prior consultation, triggered immense pressure for guarantees all
over Europe.
Other governments resented the Irish action and this has made it difficult
for the Government to make its case for burden-sharing with Europe.
Fourth, failure to seize immediate control over the management of Anglo.
It should be assumed that the existing management of a bank whose
business model has lost the confidence of the market and which has run out
of cash have neither the expertise nor the incentive to recover the situation
safely.
The public authorities should have intervened immediately to take control
of the bank, for which nationalisation was the available tool.
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Fortunately nationalisation did follow in January 2009 without evident
value destruction having taken place in the intervening period.
How much does this matter?
Having made those criticisms, it is important to keep the scale in
perspective.
The decisions on the night of the guarantee did of course have
consequences for Ireland.
But there has been a tendency to overstate the extent of the impact of that
night's decisions on the subsequent welfare of the nation.
It would be hard to deny that most - I would hazard a figure of at least
80-90% - of the overall hardship that followed the bursting of the bubble,
was (albeit unbeknownst to the decision-makers that night) already
inescapably embedded in the situation.
The damage had been made unavoidable by the unrestrained credit and
property boom.
(The fiscal austerity measures that have had to be taken are not just due to
the €40 billion or so in additional net debt that can be linked to the
guarantee, but also reflect the far larger impact of the ending of the
construction boom on the Government's tax revenue and spending needs.
And the fiscal costs are only one aspect of the total damage to Ireland).
In my letter to the Inquiry of February 12, I have distinguished between a
hypothetical "hindsight" scenario (1), in which the Government would have
been convincingly advised of the actual likely magnitude of the cost of a
guarantee, and the actual scenario (2) with only the information available at
the time.
In the actual case the Government had no information at hand indicating
that any of the banks were about to experience losses far in excess of their
capital reserves.
What I have suggested as the best course of action (given the lack of such
information Scenario 2) - buying time for negotiation with partners, seizing
control over the two failing banks, and limiting the scope of the guarantee could hardly (unless those negotiations had proved remarkably successful)
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have reduced the direct fiscal bill by more than a few billion - a fraction of
the actual damage.
The alternative (under the hindsight Scenario 1) of bailing-in some of the
bondholders and depositors of Anglo and INBS would have imposed
additional disruption to economic activity and capital formation which
would have offset a lot of the savings to the State from not paying the
creditors.
I conclude that the need for "austerity measures": the scale of tax increases
and expenditure reductions that have proved necessary since, could have
been reduced somewhat, but not all that much, by anything done at the end
of September 2008.
Maintaining perspective
As I have remarked recently, the boom and the bust both damaged our
economy.
The boom, and the decisions that were taken during it, meant that Ireland
had to adjust down from living standards that could never have been
sustained, with sizeable and capricious shifts in the distribution of wealth.
The style of banking in Ireland, its regulation and broader economic policy
were strongly influenced by comparable styles adopted at that time in
countries often used as exemplars for Irish decision makers, and in
particular the US and UK.
But the scale of the excesses in Ireland put its banking crisis in a different
league (though not as bad as Iceland).
The extent and nature of the guarantee decision frustrated subsequent
efforts to minimise the costs and speed the recovery. But the bulk of these
costs could not have been avoided by a different course of action on the
night of the guarantee.
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Basel III implementation assessments of
Hong Kong SAR and Mexico as well as
follow-up reports published by the Basel
Committee
The Basel Committee on Banking Supervision
published reports assessing the implementation of
the Basel risk-based capital framework and the
liquidity coverage ratio (LCR) for Hong Kong SAR
and Mexico.
These form part of a series of reports on Basel Committee members'
implementation of Basel standards under the Committee's Regulatory
Consistency Assessment Programme (RCAP).
A key component of the RCAP is to assess the consistency and completeness
of a jurisdiction's adopted standards and the significance of any deviations
from the regulatory framework.
For the first time, the assessments now also cover the regulatory
implementation of the LCR standards.
The RCAP does not take account of a jurisdiction's bank supervision
practices nor do they evaluate the adequacy of regulatory capital for
individual banks or a banking system as a whole.
Overall, the assessment outcomes for both Hong Kong SAR and Mexico are
positive and reflect various amendments to the risk-based capital and LCR
rules undertaken by the authorities during the assessment.
The Basel Committee noted that several aspects of the domestic rules in
both countries are more rigorous than required under the Basel framework.
Hong Kong SAR
Overall, the national implementation of the risk-based capital standards is
found to be "compliant" with the standards prescribed under the Basel
framework.
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Twelve out of 13 components are assessed as "compliant", while one
component, Pillar 3, is determined to be "largely compliant" with the Basel
standards.
The advanced measurement approach for operational risk has not been
implemented in Hong Kong SAR and was therefore not part of the
assessment.
For the LCR, Hong Kong SAR is graded overall as "compliant".
The LCR and LCR disclosure standard subcomponents are also assessed as
compliant.
The LCR assessment report provides further qualitative information
regarding the implementation of the Committee's Principles for sound
liquidity risk management and the monitoring tools for liquidity risk.
In carrying out this review, the Committee's assessment team held
discussions with senior officials and technical staff of the Hong Kong
Monetary Authority.
The team also met with a select group of Hong Kong banks.
Mexico
Overall, the implementation of risk-based capital standards is found to be
"compliant" with the Basel standards.
Twelve out of 14 components are assessed as "compliant", while the
countercyclical buffer and Pillar 3 are considered "largely compliant".
Mexico is also assessed as compliant regarding the regulatory
implementation of the LCR, including for the LCR and LCR disclosure
requirements subcomponents.
In carrying out this review, the Committee's assessment team held
discussions with senior officials and technical staff of the Comisión
Nacional Bancaria y de Valores and the Bank of Mexico.
The team also met with a select group of Mexican banks.
Post-assessment follow-up actions
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In addition to the RCAP assessment reports, today the Committee also
published overviews of post-assessment follow-up actions by Brazil, China,
Japan, Singapore and Switzerland.
These five jurisdictions were assessed in 2012 and 2013 for their regulatory
implementation of the risk-based capital standards.
The follow-up reports summarise where the jurisdictions have taken, or
plan to take, further actions to address findings raised in the RCAP
assessments.
The follow-up reports are based on self-reporting and have not been
evaluated by the Basel Committee.
The next post-RCAP monitoring report will be published in 2016 and will
cover jurisdictions that were assessed in 2014.
Notes
The Basel Committee on Banking Supervision consists of senior
representatives of bank supervisory authorities and central banks.
Member countries include Argentina, Australia, Belgium, Brazil, Canada,
China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan,
Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia,
Singapore, Spain, South Africa, Sweden, Switzerland, Turkey, the United
Kingdom and the United States.
The RCAP is a central element of the Committee's continuing efforts to
promote timely adoption of its standards and to monitor its members' full
and consistent compliance with the Basel framework.
The RCAP also helps member jurisdictions identify deviations from the
Basel framework, weigh the materiality of any deviations and undertake
necessary reforms.
Based on the findings of these assessments, many assessed jurisdictions
have already amended their regulations to align them more closely with the
Basel framework, thereby helping to promote global financial stability and a
level playing field for internationally active banks.
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The Basel Committee has previously published jurisdictional assessments
of Australia, Brazil, Canada, China, the European Union, Japan, Singapore,
Switzerland and the United States.
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Inauguration of the new ECB premises
Speech by Mr Mario Draghi, President of the
European Central Bank, at the inauguration of the
new ECB premises, Frankfurt am Main, 18 March
2015.
I am delighted to welcome you all today to the
inauguration of the new European Central Bank
headquarters.
Creating our new home is a project as old as the ECB itself. It began in 1998
with the search for a suitable site. In 2001 we found that site here at the
Grossmarkthalle.
A year later, an international competition was launched for the best
architectural design, which was eventually won by Wolf Prix and his team.
And in May 2010 the foundation stone was laid and the main construction
works started.
Many people, some of them here today, have worked tirelessly over this
period to make this project a reality.
I would like to thank everybody involved for such tremendous work.
The euro, our single currency, has become the most tangible symbol of
European integration - a piece of Europe accessible and valuable to each
and every one of us.
This building will inevitably become known as the "house of the euro".
It provides a sound foundation for the ECB to pursue its mandate of
maintaining price stability for all euro area citizens.
In that sense, the building is a symbol of the best of what Europe can
achieve together. But it is also a symbol of why we can never again risk to
split apart.
We are standing here today in what used to be Frankfurt's former wholesale
fruit and vegetable market, a state-of-the-art functional building from the
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1920s that has largely been preserved and incorporated into the new
structure.
Between 1941 and 1945, more than 10,000 Jewish people from Frankfurt
and nearby were deported from here to the concentration camps.
A memorial on the east-side of the building has been built to remind us, and
those who come after us, of deeds that cannot and must never be forgotten.
An integrated, democratic and peaceful Europe was one of the key lessons
from this dark chapter in history.
We have come a long way since then - but nothing we have achieved should
be taken for granted.
European unity is being strained. People are going through very difficult
times.
A recent Eurobarometer survey on how households in several countries are
coping with the crisis showed that all respondents had been affected by a
loss of income, and almost all said life was worse since the crisis hit.
As an EU institution that has played a central role throughout the crisis, the
ECB has become a focal point for those frustrated with this situation.
This may not be a fair charge - our action has been aimed precisely at
cushioning the shocks suffered by the economy.
But as the central bank of the whole euro area, we must listen very carefully
to what all our citizens are saying.
There are some, like many of the protestors outside today, who believe the
problem is that Europe is doing too little. They want a more integrated
Europe with more financial solidarity between nations.
And there are others, like the populist parties we see emerging across
Europe, who believe that Europe is doing too much. Their answer is to
renationalise our economies and reclaim economic sovereignty.
I understand what motivates these views, why people want to see a change.
Yet in truth neither offers a real solution to the situation we face today.
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Solidarity is central to European integration and it is right that countries
have supported each other during the crisis. But the euro area is not a
political union of the sort where some countries permanently pay for
others.
It has always been understood that countries have to be able to stand on
their own two feet - that each is responsible for its own policies. The fact
that some had to go through a difficult period of adjustment was first and
foremost a consequence of their past decisions.
Nevertheless, standing on one's own feet is not the same thing as standing
alone. Renationalising our economies is also not the answer.
It would not change the basic economic realities that European countries
confront - that we are ageing societies which have to grow primarily
through raising productivity.
And it would not offer citizens any more economic security.
There is no country in the world that is both prosperous and insulated from
globalisation.
In fact, the Single Market process was introduced precisely because
European economies, acting alone, could not create enough jobs in an
increasingly open world.
And that process led in turn to monetary union because - as the ERM crisis
in the early 1990s showed - countries realised they could not integrate in
part and benefit in full.
The financial and sovereign debt crises since 2008 have only reaffirmed
that truth.
So the answer is not to unwind integration. Nor is it to hold out an
unattainable vision of where integration should lead.
It is to complete our monetary union in the areas where it can and needs to
be completed.
We need ambition in our ends and pragmatism in our means.
We have already shown how this can be done with the solidarity and
stabilisation mechanisms that were set up during the crisis. Banking Union
is also a remarkable achievement.
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Now we need to make progress in the other areas that remain unfinished,
notably in terms of economic and institutional convergence.
Still, I recognise that we cannot have a purely economic perspective on the
questions facing our Union.
While economic integration produces more jobs and growth on aggregate,
this does not completely solve the problem that drives dissatisfaction with
the euro and the EU.
There is also the problem of distribution: who gains and who loses from
that process?
For example, higher labour mobility across countries might reduce
unemployment, but it can also stoke fears about immigration and create
insecurity for low-skilled workers.
Opening up a previously protected sector might reduce costs for consumers,
but it can also leave citizens employed there with an uncertain future.
So, if we are to build lasting confidence in our Union, we still need to
address this tension - to reconcile the economics of integration, which is
about efficiency, with the politics of integration, which is about equity.
This is a complex issue, but a solution can be summed up in one word:
skills.
Theoretical and empirical research both suggest that recent technological
change has been skill-biased.
In other words, production technology has shifted in a way that favours
skilled over unskilled labour, by increasing its relative productivity and
therefore its relative demand.
Equipping workers with the right skills therefore makes the economy more
efficient and creates new job opportunities.
And it also makes the economy more equitable by allowing as many citizens
as possible to participate in those opportunities.
For this reason, education and training need to be as much a part of the
reform agenda as creating more flexible markets and reducing red tape.
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But there is also a second way in which the economics and politics of
integration need to be reconciled.
The more decision-making over economic issues moves to the European
level, the more democracy needs to move with it.
This is not just because democracy is a core value of the EU. It is because
making policy without adequate representation and accountability does not
work.
So we need to deepen our economic union and our political union together.
And this means strengthening the channels for genuine European
democratic legitimacy, like the European Parliament.
Inevitably European democracy will be different. Voters in any one country
may initially fear that they have less influence over decisions than at
present.
But it is my belief and certainly what has happened in the monetary policy
area that in giving up some formal sovereignty, people will gain in effective
sovereignty.
They will empower institutions with euro-wide responsibilities able to
tackle the pressing problems of jobs and growth - and so their votes may in
fact make more of a difference to their lives than they do today.
In this way, I trust, we can reconcile those who feel left out, including many
of the protesters gathered in Frankfurt this week, with a process of
integration that has already generated so many benefits for three
generations of Europeans.
Let me conclude.
This building is a credit to all those who have worked to bring it to fruition.
It is a landmark for the city of Frankfurt. And it provides the ECB with an
impressive new home to pursue its mandate.
But it also stands as a powerful symbol of what European integration is
about.
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It reminds us of where we have come from and where we have come to. Of
the horrors that can happen when we split apart, and the huge steps
forward we can make when we work together.
So let us not undo what has been achieved. Let us not hanker for the past.
Let us draw on the past to unite us in the present - to build a complete
Union that can deliver the stability and prosperity we need.
We as the central bank will do our part in this process by ensuring the
integrity of our single currency.
Our shared money is the most tangible sign of the trust we place in one
another.
As the ECB's first President, Wim Duisenberg, put it at the launch of the
euro more than 16 years ago:
"A currency is far more than just a medium of exchange - A currency is also
part of the identity of people. It reflects what they have in common, now
and in the future."
Thank you for your attention.
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Celebrating Pi Day at the National
Cryptologic Museum
Saturday, 14 March 2015, 0900-1200
This once-in-a-lifetime event featured pi related activities for the whole
family, to find the diameter of a head using pi;
make a bead bracelet in pi order; hear the story of
"Sir Cumference and the Dragon of Pi;" and much
more.
Visitors could also tour the museum to learn all
about our cryptologic history.
As you know, pi to the tenth digit is 3.141592653,
and by day/time that is March 14, 2015 at 09:26:53
making this year very unique.
This date won't roll around again for 100 years.
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The Pi song:
http://www.piday.org/2010/mathematical-pi-song/
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Remarks at the University of Notre Dame,
Mendoza College of Business, Center for the
Study of Financial Regulation
Commissioner Michael S. Piwowar
Notre Dame, IN
Thank you so much Paul [Schultz] for that kind introduction and for the
invitation to join you today.
It is a privilege to be among so many outstanding market microstructure
scholars.
As I look around the room, I see many familiar faces, including former
colleagues and people — like you, Paul, and [Mendoza College of Business]
Dean Roger Huang — whose research influenced my decision to study
empirical market microstructure.
Before I proceed, I need to provide the standard disclaimer than the views I
express today are my own and do not necessarily reflect those of the
Commission or my fellow Commissioners.
Today, I want to focus my remarks on the equities markets, and specifically
equity market structure.
Although it may be hard for some of you in this room to believe, in the 20
months since I began this job, some have suggested that I am a so-called
“market structure expert.”
While such comments are certainly flattering, I cannot accept the
compliment.
Of course, my academic research, my private and public sector experience,
and my current role as a Commissioner at the Securities and Exchange
Commission (“SEC” or the “Commission”) have all given me unique
insights into the functioning of our equities markets.
However, like many people in this room, I still consider myself a “student of
markets.”
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With so many issues to examine and debate, and the continued evolution of
the financial markets, I think we can agree there is more for all of us to
observe and learn.
It has been fifteen months since I gave my first speech on equity market
structure.
Both before and since, my colleagues at the Commission have kept the issue
of market structure in the forefront through their own public remarks.
Congress also has been expressing keen interest in equity market structure,
shining a bright light on the issue.
And we have had some unsolicited prompting by a bestselling author, who,
to put it lightly, does not have flattering things to say about the current state
of the equity markets in what many refer to as simply “The Book.”
Given all of this attention, I am frankly disappointed that we at the SEC
have accomplished very little.
Rather than merely expressing my frustration with our lack of movement in
this area, I first want to point out two positive things the Commission has
done in pursuit of a market structure review.
First, we have made progress with respect to a tick size pilot program for
small capitalization companies.
By way of background, such a pilot program would test the benefits and
costs of an alternative minimum price increment for small-cap stocks,
which generally have lower liquidity than other market segments.
Last summer, the Commission ordered the self-regulatory organizations
(“SROs”) to develop a plan to implement the pilot.
We have since published their plan for public comment.
Before any pilot program can begin, the SEC has to consider the
approximately 75 comments we have received to date and evaluate whether
the program, as proposed by the SROs, is in furtherance of the purposes of
the Securities Exchange Act.
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I understand that the Staff is diligently undertaking that analysis, and I am
hopeful that the Commission will take prompt action so a pilot can
commence soon.
Second, the Commission recently finalized the composition of a Market
Structure Advisory Committee that was announced by Chair White in June
of last year.
The Committee will focus on the structure and operations of the U.S.
equities markets, and the Chair has described its function as a forum and
resource for reviewing specific, clearly articulated initiatives or rule
proposals.
Given the talented individuals comprising the Committee, I have no doubt
that they will provide the Commission with valuable insights while
undertaking this narrow function.
However, I believe it would be a shame to convene this group of experts and
then limit the scope of their discourse from the outset.
That is why I will be challenging the Committee to think broadly about their
mandate and what they can contribute to the overall market structure
dialogue.
As an initial matter, the Committee, rather than the Commission, should be
identifying the right questions to be asked in a market structure review. ‘’
The contours of an issue can be best explored from all angles, and we do not
want to miss a key line of inquiry by ignoring the vast experiences and
expertise of the Committee members.
In addition, the Committee should recognize that its mandate grants it the
authority to serve as an independent source of recommendations, instead of
simply acting as a sounding board for ideas generated by the
Commissioners or the SEC Staff, or suggestions dusted off from prior
discussions.
We will never fully tap into the promise the Committee holds unless we free
it to undertake an independent analysis of the complex issues confronting
us in this space.
Despite some indications of progress, neither the tick size pilot nor the
SEC’s Market Structure Advisory Committee discussions are yet underway.
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Therefore, it is not too late to participate in and influence the market
structure debate.
In fact, I would like to spend the balance of my time with you today
discussing the role of both academics and industry in charting the future
course of our equity market structure.
Specifically, I would like to enlist your help as the Commission hopefully
shifts from talk about equity market structure to action.
The perspectives of academic market microstructure researchers will not
only be important.
They will be vital.
The Vital Role of Academics
Academics are too often criticized for sitting in a proverbial ivory tower,
sheltered from the practical concerns of everyday life.
Surely I am not the only one in this room that has disdain for that pejorative
characterization.
The truth is that academic research can have real, measurable influence.
As someone who has spent time navigating the academic journal
publication process as well as the Washington, DC policymaking processes,
I would like to make a few personal observations about how academics can
truly inform policymaking through their scholarly work, particularly in the
area of market structure.
To start, I urge you to keep policy implications in mind as you construct and
conduct your research.
Too often, policy implications are simply an afterthought added to an
already-finished working paper just prior to submitting it to a conference or
journal.
In my several years in Washington, DC, I have had the honor to serve in
several capacities in the federal government — at the SEC as an economist,
at the White House during two presidential administrations, on Capitol Hill
as an economist on the Committee Staff for two Senators, and now back at
the SEC as a Commissioner.
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From my various perches, I have been the consumer of your great work, so I
know just how much academic research can enrich the policy discourse.
To name just a couple significant contributions to the equity market
structure conversation — from right here at the Notre Dame Mendoza
School of Business — Robert [Battalio] and Shane’s [Corwin] recent
co-authored paper with Bob Jennings on order routing and execution
quality prompted a vigorous debate on Capitol Hill, at the Commission, and
elsewhere.
We all know that correlation does not always imply causation, but we also
know that Paul’s [Schultz] paper with Bill Christie, and their follow-up
paper with Jeff Harris, were associated with pronounced changes in market
maker quoting, as well as a criminal investigation and a billion dollar
settlement of a class-action lawsuit.
Paul, Robert, and Shane’s research has not only been groundbreaking and
thoughtful, but it has also been quite impactful, beyond the narrow
meaning of the term “impact factor” used by academic research journals.
This may seem self-evident, but to be truly impactful, you need to be visible.
I encourage you to make policymakers aware of your research. It can be as
straightforward as identifying the relevant decision-makers and forwarding
your papers directly to them and their staffs.
Or you can contribute to the discussion by submitting comment letters to
administrative agencies like the SEC.
We, for example, have a robust public comment process on each and every
rulemaking, and I assure you we pay attention to what we hear.
Unfortunately, the number of comments received from academics is often
disproportionately low relative to other groups.
I hope you will consider submitting comments that let us know how our
rules and regulations stand up to what we articulated as the expected
impacts, identify opportunities to further enhance the regulatory system,
opine on the likely economic consequences of an action, and suggest
measures of success.
As you prepare any of those comment letters, please keep in mind that
submissions are especially impactful when they include the empirical
evidence and analysis that underlies the position being advocated.
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Academics are perfectly situated to make such data-driven observations.
And speaking of data, I continue to be a self-appointed marketing executive
for the SEC’s innovative Market Information Data Analytics System
(“MIDAS”).
MIDAS has data about every displayed order posted on national exchanges.
The Commission uses MIDAS internally to, among other things, monitor
market behavior, understand market events, and test hypotheses about the
equity markets. But we also make a number of data series freely available to
the public.
Please download the data, conduct analyses, and come back to us with your
empirical findings.
Let the Commission know whether, and if so how, the data is useful for
teaching purposes. We promise to take the feedback constructively.
Further, to the extent you have occasion to be in Washington, DC and you
would like to discuss your research, please reach out. Do not underestimate
your ability to get a meeting with policymakers.
I know I am not the only one — at the SEC or on Capitol Hill — that makes
every effort to meet with anyone who expresses interest in discussing
market structure issues.
Schedules are challenging, but I find I am able to accommodate a
surprisingly large number of requests.
And I learn more listening to academics engaged in thoughtful market
microstructure research than from the usual inside-the-Beltway suspects
and their buzzword-laden talking points.
One more seemingly obvious point: visibility and relationships lead to
opportunities. It is incumbent upon us as policymakers to affirmatively
reach out to tap into your expertise.
The Commission needs to hear a diversity of viewpoints, by bringing
together people from academia and industry as collaborators.
And we can surpass government constraints — financial and otherwise — by
leveraging outside resources, such as academic research.
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To this end, you may be invited to participate in roundtables hosted by the
Commission or other interested parties.
The SEC also offers academics short-term fellowships to work in one of our
Divisions, which can be mutually beneficial. In fact, I understand a few of
the SEC’s fellows are here today.
The House or Senate may extend invitations to testify in hearings as a
subject-matter expert.
And so on and so on. I implore you to accept such requests.
Before leaving this topic, I want to briefly circle back to the SEC’s current
equity market structure initiatives.
I have every expectation that the willingness of academics to serve on the
SEC’s Market Structure Advisory Committee will substantially improve the
output.
Former SEC Chief Economist Chester Spatt is among the members of that
Committee, as are other distinguished academics Maureen O’Hara and
Andy Lo.
Their views, both individually and collectively, will certainly influence how
the regulation of equity market structure evolves.
Along the lines of what I have already said, however, it is important to keep
in mind that the Commission will not be listening to the members of the
Committee to the exclusion of other voices.
You can stay involved by “speaking” through your scholarly works, or by
talking directly to Chester, Maureen, or Andy, to the Staff of the
Commission, to the Chair and other Commissioners, or to me personally.
I also look forward to reading academic research papers that will study the
effects of the tick size pilot program.
The Commission’s order directing the SROs to develop a plan to implement
the pilot requires them to provide to the Commission and make publicly
available their assessment of the impact of the pilot no later than eighteen
months after the beginning of the pilot.
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I have asked Chair White to hold a public roundtable to discuss the results
of their assessment, the results from academic research papers that study
the pilot, and the practical application of the evidence presented.
Industry Involvement
Now that I have laid out the status of Commission efforts to evaluate the
current equity market structure, and the considerable assistance academics
can offer by engaging with policymakers, I want to spend a few minutes
discussing another key constituency in the market structure discussion, the
securities industry.
Rather than waiting around for the SEC to finally begin tackling these
complex issues, members of the securities industry are taking proactive
steps with respect to equity market structure.
To provide just one specific example of extensive industry engagement in
this area, a petition for rulemaking was submitted to the SEC that proposes
reform of, among other things, access fees and order handling
transparency.
We also have received a number of white papers that discuss and make
recommendations on a range of key issues.
For its part, Nasdaq designed and is conducting an access fee pilot.
This experimental pricing program, which is limited to fourteen stocks,
lowers the access fee on Nasdaq from 30 cents per 100 shares to five cents
per 100 shares and reduces rebates for liquidity provision.
The pilot is generating data about how lower access fees affect the quality of
the markets for investors and public companies, as well as the level of
off-exchange trading, price discovery, trading costs, and displayed liquidity.
Nasdaq has committed to periodically share the results of the program.
(By the way, if anyone in the audience has been studying the Nasdaq access
fee pilot and cares to share their preliminary findings, please let me know
after lunch.)
Because private enterprises are far more nimble than the government,
initiatives like Nasdaq’s that are voluntarily undertaken are much more
efficient than Commission programs.
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Such experiments, whether they produce results favorable or unfavorable to
the theories being tested, will have true value as a supplement to what we at
the Commission may be trying.
By mentioning the Nasdaq pilot, as well as the SEC’s tick size study, I do not
mean to overstate the role of pilots or be interpreted as supportive of any
and all pilots under any and all circumstances.
To be clear, pilots, whether initiated by the Commission or an industry
participant, have limitations.
The design matters — which securities are included in the pilot, the control
samples, the duration, and the data collected, etc.
We must always be mindful that pilots also impose costs on market
participants.
Careful cost-benefit analyses must be conducted before and during the
implementation of any pilot program to ensure that investors or issuers are
not unduly harmed.
Finally, it is worth noting that structured pilots are not the only way to
evaluate equity market structure issues, or that market participants can
participate in the discussion.
We continually see new entrants to the market that challenge the existing
business landscape, which then serves as a natural experiment.
In this way market dynamics themselves will ultimately show whether a
new approach has positive or negative impacts on market quality measures,
reveals insights about equity market structure generally, or exposes a
market imbalance created by regulation.
Conclusion
Let me close with the words of someone I hear is still pretty popular around
here — Lou Holtz.
“I never learn anything talking. I only learn things when I ask questions.”
With respect to a review of equity market structure, the SEC can only get so
far through internal discussion and debate.
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We will be posing a lot of questions, and I hope the academic community
and industry will continue to provide us with vital data, analysis, and
feedback.
Thank you for your attention.
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