PwC Discusses the Fed’s New Rating System for Large Financial Institutions

On August 3, the Federal Reserve (Fed) proposed for comment a new supervisory rating system to assess the safety and soundness of Large Financial Institutions (LFIs).1 This is the first change to the Fed’s supervisory rating system since the financial crisis, and aims to simplify and clarify the existing five-component supervisory assessment process2 by assigning ratings across three pillars: (1) capital, (2) liquidity, and (3) the effectiveness of governance and controls.

1. Doubling down on capital and liquidity. The proposal is designed to focus future ratings on two areas where the Fed has made the most changes … Read more

Davis Polk Offers Tips on Preparing for CFPB’s New Arbitration Rule

Since the CFPB issued its Arbitration Rule in July, most commentators have focused on ways the rule may be blocked from going into effect.  Chief among these is the possibility that Congress will vote to overturn the rule under the Congressional Review Act, and the House did promptly vote in favor of overturning the rule on July 26, 2017.  The Senate began its August recess without a vote to overturn the CFPB Arbitration Rule and with no indication for when it might take the matter up again. In light of that uncertainty, it is now time for financial institutions to … Read more

Stocks May Be Expensive but Not Overvalued

Publications like Bloomberg, The Financial Times, and The Wall Street Journal[1] have recently reported that current stock markets and especially those in the United States are more overvalued than ever. In an interview with the Financial Post[2], David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc., added that U.S. stocks are “supremely overvalued.” This suggests that a period of gloom might be closer than anticipated. There is, in fact, good reason for investors to be concerned. In terms of price earnings ratios[3], the S&P 500 Index has been trading at an … Read more

PwC Discusses Fed’s New Board Expectations Guidance

On August 3, the Federal Reserve (Fed) proposed for comment supervisory guidance for boards
of directors of Fed-supervised institutions1 (i.e., Board Effectiveness (BE) guidance). The proposed BE guidance is the result of a multi-year review by the Fed of existing guidance and practices of boards of directors across supervised firms. It is intended to consolidate and replace existing board supervisory expectations from 27 SR Letters, which include 170 supervisory expectations for boards, with 33 expectations of effective boards. The 33 proposed expectations are categorized into five attributes which the Fed intends to assess a firm’s board of directors, including: … Read more

Corporate Bond Trading on an Exchange

An over-the-counter (OTC) market and an open limit order book (LOB) market are the two common mechanisms for organizing financial markets. An OTC is a decentralized market, where trades occur only through dealers. The dealers’ quotes are not fully transparent and are not binding, so customers can shop around and negotiate for the price. An open LOB is a centralized market, where traders submit anonymous orders to a central order book. The quotes are transparent and binding, traders can trade among themselves, and the transactions are transparent as well.

Corporate bonds are traded worldwide mostly in OTC markets while stocks … Read more

PwC Discusses Bank Resolution Plans’ Public Sections

The recently released public sections of the 2017 resolution plans submitted by the eight US global systemically important banks (G-SIBs)1 provide a unique window into the banks’ resolution planning efforts that have developed over the last five years. Notably, the 2017 plans not only describe how the banks have enhanced their resolution plans but also highlight improvement in their intrinsic resolvability, which is indicative of the mindset change that has evolved over the past seven years: resolution planning has developed from a one-time compliance “project” to an important strategic consideration for business-as-usual (BAU) financial and operational choices.

These fifth… Read more

The Beginnings of the U.S. Capital Gains Tax Preference

With the recent release of the Trump administration’s tax plan, discussions of tax “reform,” or at least tax cuts, are once again at the center of American law and politics. Although the president’s tax plan is short on details, it has plenty of potential benefits for high-income earners, including a reduction in top marginal income tax rates and a modest decrease in the tax rate on capital gains. More specifically, the White House tax plan seeks to repeal the 3.8 percent Obamacare tax on net investment income, thereby increasing the tax preference for realized gains from capital investments.

Unsurprisingly, the … Read more

Targeting Corporate Inversions: Are We Doing the Right Thing?

Congress, the U.S. Department of the Treasury (“Treasury”), and countless legislators have criticized corporate inversions — mergers designed to help American companies lower their tax bills by moving overseas — since McDermott International completed the first one in 1982. Nearly 59 percent of registered voters across the country believe it is Congress’ duty to stop such deals, according to a 2015 study, but about 35 years after the first one, little progress has been made. Every law against these transactions is met with a creative way around it. In other words, when Congress and the Treasury close one loophole, another … Read more

What Responsibilities Do Sovereign Funds Have to Other Investors?

With trillions of dollars in assets, sovereign wealth funds (SWFs) play a major role in financial markets around the world. With billions (and perhaps trillions) of dollars’ worth of equity investments around the world, the investment behavior of SWFs is of primary concern to regulators, portfolio firms, and other investors. Most work on SWF equity investments has focused on the challenges that SWFs present to regulators, portfolio companies, or their own domestic constituencies. In a forthcoming essay, I seek to provide a realistic appraisal of the benefits and potential costs of SWF investment for other investors.

As numerous scholars have … Read more

How Substitutable Are Workers? Evidence from Worker Deaths

The fluidity of labor markets depends on the ease with which one side of the market can fulfill the needs of the other: whether workers can find employment that suits their skills and firms can find adequate substitutes for workers who leave. Today much is known about the worker’s perspective. A large body of empirical literature documents that workers suffer persistent earnings losses after they have been displaced from their job – in line with Becker’s (1962) idea that human capital has firm-specific components (see, e.g., Topel 1991; Jacobson et al. 1993; and Dustmann and Meghir 2005).

The other side … Read more

Jones Day Discusses IRS Rulings on Spin-Off Issues

In Short

The Situation: The IRS had discontinued issuing private rulings on certain transactions related to spin-offs, leaving companies to wonder if favorable tax treatment was likely.

The Action: Recent IRS guidance announced the resumption of private rulings in transactions under consideration, and provided confirmation that certain “north-south” transactions will not adversely impact second-step spin-offs.

Looking Ahead: Further clarification on these matters is necessary, and additional guidance on spin-offs may be in the offing.

The IRS recently provided taxpayers with favorable guidance involving tax-free spin-offs. First, the IRS will resume issuing private rulings that allow a distributing corporation to satisfy … Read more

How Tax Policy Favors Robots over Workers and What to Do About it

There is a longstanding and growing public debate about the costs and benefits of automation. Earlier this year, Bill Gates argued that robots who take human jobs should pay taxes. Mark Zuckerberg recently warned the graduating class at Harvard University that, “Our generation will have to deal with tens of millions of jobs replaced by automation like self-driving cars and trucks.” Elon Musk has joined the ranks of industrialists in favor of guaranteed minimum income, which he says will be necessitated by automation.

It isn’t just industry leaders who are aware of the problems automation poses. This year the EU … Read more

How to Regulate TechFins and Data-Based Finance

In a new research paper, we consider the impact of a group of new entrants into financial services and regulation. These new entrants include technology, e-commerce, social media, and telecommunications companies with often large pre-existing bases of non-financial services customers. These firms (loosely termed “TechFins”) may be characterized by their capacity to leverage data gathered in their primary businesses into financial services by the use of Big Data analytics, machine learning, and artificial intelligence. Initially they often act as conduits linking their customers to regulated financial firms.

China’s Alibaba with its subsidiary Ant Financial is the frontrunner, and its founder, … Read more

Fed Governor Brainard Discusses Why Opportunity and Inclusion Matter to U.S. Economy

I want to thank Neel Kashkari for launching the Opportunity and Inclusive Growth Institute and for inviting me to join the deliberations of this distinguished group today [May 22]. This new Institute is another great example of how individual Reserve Banks are taking the initiative in illuminating key dimensions of our work and shaping the agenda of the Federal Reserve System.1

While it has long been understood that opportunity is central to the strength of America’s social fabric, it is now increasingly clear that opportunity and inclusion are central to the strength of America’s economy. I will touch on … Read more

Are Hedge Funds Worth As Much As They Say They Are?

In 2001, hedge fund manager Cliff Asness co-wrote a famous paper, Do Hedge Funds Hedge?1 Sixteen years later, amid significant changes in the industry, it’s worth asking, Are hedge funds worth as much as they say they are? And what explains the expectation, as reported by Preqin,2 that outflows from hedge funds will continue in 2017 (I suspect either performance-related or cost-related issues, or both)?

Using the CSFB/Tremont Hedge Fund Index’s monthly returns from January 1994 to January 2014,3 I conducted a study similar to the one described in Asness’s paper. I tried to determine whether hedge … Read more

The Monitoring Role of the Media: Evidence from Earnings Management

The news media are an important source of information for the U.S. capital markets, especially when drawing attention to questionable behavior of corporate executives. Coverage can, however, pressure companies into making dubious financial decisions like emphasizing short-term earnings over long-term value. In our recent article, we explore the effect of media coverage on earnings management to shed light on the media’s role in the U.S. capital markets.

Earnings management is the use of accounting techniques to produce financial reports that misstate a firm’s business performance and financial position. There are two main mechanisms through which managers manipulate earnings: accrual-based and … Read more

Better Responses to Financial Crises

How can regulators best respond to financial crises? In a forthcoming article in the Duke Law Journal, I show how a law-and-economics framework can guide regulators’ responses. There are two kinds of remedies for failing to comply with a law: property rules and liability rules.  Liability rules require compensation, such as money damages.  Property rules impose draconian penalties, such as injunctions, punitive damages, or large fines.  Property rules can make sense during normal times, because the threat of harsh penalties ensures compliance.  But financial crises upend many normal assumptions and prevent some entities from complying with all of their legal … Read more

A Tax on Aggressive Tax Planning

Tax planning by multinational enterprises (MNEs) is estimated to generate a worldwide loss of corporate tax revenues of between $100 billion and $240 billion. U.S.-based MNEs alone are believed to retain a total of $2 trillion in earnings outside the U.S., largely for tax reasons. Over the last few years, the Organization for Economic Cooperation and Development (OECD) has been trying to come to grips with the tax reduction strategies of MNEs. Its results, presented in the 2015 final reports of BEPS (Base Erosion and Profit Shifting) have disappointed many. That is understandable: Most of the proposals depend on further … Read more

Fed Vice-Chair Fischer Discusses Committee Decisions and Monetary Policy Rules

It is a pleasure to be at the Hoover Institution again. I was privileged to be a Visiting Scholar here from 1981 to 1982. In addition, many of the researchers and practitioners with whom I have discussed monetary policy over the years have had affiliations with the Hoover Institution–including several people here today. It is a pleasure also to have been invited to speak at this Hoover Institution Monetary Policy Conference, for the Hoover conference series provides a valuable forum for policymakers and researchers to engage in dialogue about important monetary policy issues facing the United States and other countries.… Read more

The Agency Costs of Teamwork

It is common wisdom among transactional lawyers that good teamwork results in smoother deals and better service for their clients.  Perhaps for this reason, capital-markets practices frequently tout their teamwork skills as a source of value for clients, especially in securities offerings where lawyers acting for issuing companies work closely with underwriters and their lawyers in a team-like fashion, all pulling for the success of the issuing company.

However, teamwork holds a potential pitfall for transactional lawyers, because their desire to work collaboratively with other parties in a deal can blunt their ability to advocate effectively on behalf of their … Read more