Reforming the Macroprudential Regulatory Architecture in the United States

When the COVID-19 pandemic shuttered major economies in March 2020, it also wreaked havoc on financial markets. In the first few weeks of March, investment-grade corporate bonds lost roughly a fifth of their value, on par with the declines in equity and high-yield debt. (Haddad et al., 2020; Falato, Goldstein & Hortaçsu (forthcoming)). Contrary to the usual flight to quality, in mid-March, U.S. Treasury yields began rising and only stabilized after the Federal Reserve initiated a massive purchase program. (Vissing-Jorgensen, 2020). The distress in the Treasury market accentuated distress in other markets and liquidity challenges for firms. Nonbanks that service … Read more

Why We Need to Verify and Unmask the Identity of Cryptocurrency Users  

Cryptocurrencies are by now widely known as electronically generated and stored currencies that enable users to trade tokens. The tokens are exchanged anonymously through a decentralized payment system: the blockchain. To further anonymity, the parties to cryptocurrency transactions are identified by a unique string of random numbers rather than by a name or other personal information.

There is however a dark side to this anonymity. It makes it easier for criminals and terrorists to launder money and otherwise transact illegal business. For example, anonymous tokens provide terrorists with access to cash that is essential to organizing attacks without dependency on … Read more

How Does Removing the Tax Benefits of Debt Affect Firms?

Almost all countries have historically allowed businesses to write off interest expenses against taxable income. Critics argue that the tax-favored status of debt has created a corporate debt pile-up, thereby exacerbating economic downturns. This argument, which gained more attention after the 2008 global financial crisis, implicitly assumes that the tax incentives have led to a large increase in the use of debt. However, despite extensive efforts by researchers, it is an open question whether the tax incentives are indeed a primary determinant of corporate debt policy. This is mainly because isolating the impact of interest deductions from other tax effects … Read more

Do Public Financial Statements Influence Venture Capital and Private Equity Financing?

Venture capital and private equity funds are important equity investors in private companies (Hand 2005; Stromberg 2008; Kaplan and Stromberg 2009), and their investments are characterized by an extensive search process that imposes significant upfront costs for the funds (Chen et al. 2010; Teten and Farmer 2010; Gompers et al. 2016, 2019).[1] We hypothesize that private companies’ public financial statements (and the information therein) can mitigate these costs by providing a relatively less costly screening tool to identify potential targets at the pre-investment stage. In particular, public financial statements can help VC and PE funds to identify potential investment … Read more

Risk and Ambiguity in Turbulent Times

Over the past 50 years, the financial markets have been rocked by major shocks, which have led to the introduction of financial instruments that could cope with uncertainty in general and extreme events in particular. To manage the uncertainty surrounding the financial markets, there was a need for reliable uncertainty indicators. The traditional measure of uncertainty―stock volatility―has been challenged by advanced statistical methodologies (GARCH) and derivatives-based forward-looking forecasts (VIX).  In a new paper, we discuss the history of volatility and uncertainty measures, their informativeness, and the information derived from volatility derivatives.

Volatility measures (simple historical volatility, ARCH/GARCH, and the VIX) … Read more

Sullivan & Cromwell Discusses New FDIC Guidance for Specified IDIs’ Resolution Plans

On June 25, 2021, the Federal Deposit Insurance Corporation published new guidance for resolution plans to be filed by insured depository institutions with $100 billion or more in total assets. The guidance establishes a three-year filing cycle for these IDIs, with filers clustered into two groups; provides details regarding the content that filers will be expected to prepare; creates greater flexibility with respect to the incorporation of content from other sources; allows affiliated filers to submit a single, combined submission; and streamlines some of the content requirements that have proven to be less relevant to the FDIC after reviewing plans … Read more

The Importance of Context for Numbers in Earnings Conference Calls

Numbers generally convey a sense of certainty – especially in accounting and finance. However, this perceived precision also makes it easier to use them in misleading ways. An extensive literature in political science and mass communications discusses how numbers, taken out of context, can bolster weak arguments. For instance, mortality rates are often cited to argue for certain foreign and public policies because they elicit strong feelings. However, mortality rates are complex estimates with large margins of error.

In financial disclosure, firms can use numbers to mislead and create a false impression of a firm’s outlook – potentially to the … Read more

Are Earnings Announcements More Useful than Other News for IPO Pricing?

We study the relative usefulness of earnings announcements for valuation from the perspective of information externalities: the use of industry peer information for valuation, particularly for IPO pricing. Externalities of accounting information are one of the primary justifications for disclosure regulations. Assessment of the usefulness of earnings announcements is therefore incomplete without understanding how such information is used for peer equity valuation.

It is not obvious that earnings announcements or other information should matter more for peer share valuation. Prior research suggests that accounting information is by nature low frequency, not discretionary, and primarily backward-looking. Other information, in contrast, is … Read more

The Psychology of Taxing Capital Income

Facebook CEO Mark Zuckerberg’s wealth has increased by over $100 billion since 2004, but he has paid relatively little income tax. Why? Because of the “realization rule:” Zuckerberg has not sold—and thus “realized” the gains on—the great majority of his Facebook shares, so he’s not taxed.  The realization rule creates a host of problems, including huge revenue losses and inefficient investment incentives.  Indeed, the Senate Finance Committee Chair plans to introduce a bill to repeal the rule for liquid assets for rich taxpayers. In a new article, we explore public attitudes toward taxing unsold gains and find the … Read more

ISS Discusses Liquidity Behavior in the S&P 500

As a large cap index all the constituents of the S&P 500 are highly liquid. This is certainly true compared to mid-cap or small cap stocks. There are, though, high, and low rent districts within the S&P and the most liquidity is concentrated in a few stocks with the largest market capitalizations. We treat large-cap stocks differently than mid-caps when thinking about trading strategies largely because of their different liquidity profiles. Should we consider making similar distinctions within the S&P 500 itself?  Understanding variations in the liquidity characteristics of different S&P 500 stocks can help determine the optimal participation rate … Read more

Who Will Regulate Central Bank Digital Currencies?

Though a bit provocative, this headline raises a liminal question on the various projects of Central Bank Digital Currencies (CBDBs): Which  governance will apply to them? Or as Juvenal, the poet in ancient Rome, famously asked, “Who will guard the guards themselves?”[1]

What Is a Central Bank Digital Currency?

A CBDC is the digital form of a country’s fiat currency and, like traditional currency, represents a claim on that country’s government. Instead of printing money, the central bank issues electronic coins backed by the full faith and credit of the government.[2] As a result, for the first time, … Read more

Davis Polk Discusses Who Can Have a Federal Reserve Master Account

The proposed guidelines that the Board of Governors of the Federal Reserve System (the Board) recently issued for public notice and comment mark the latest development on one of the most important policy questions for the U.S. financial system today: who is entitled to have a master account?  Having an account at one of the twelve Federal Reserve Banks (a master account) is necessary for an institution to have direct access to the Federal Reserve’s payment systems and to settle transactions with other participants in central bank money.[1]  “With technology driving rapid change in the payments landscape,” … Read more

Sullivan & Cromwell Discusses New York Legislation on End of U.S. Dollar LIBOR

On April 6, 2021, the State of New York adopted long-anticipated legislation addressing the cessation of  U.S. Dollar LIBOR (“LIBOR”).  The legislation provides a statutory approach to so-called “tough legacy” contracts (contracts that (1) reference LIBOR as a benchmark interest rate but do not include effective fallback provisions in the event LIBOR is no longer published or is no longer representative, and that (2), in the case of overnight, 1-month, 3-month, 6-month and 12-month LIBOR, will remain in existence beyond June 30, 2023, or, in the case of the 1-week and 2-month LIBOR, will remain in existence beyond December 31, … Read more

Shearman & Sterling Discusses How UK Banking Is Affecting Global FinTech

In an increasingly virtual world, law and regulation act as a vital safety net for businesses. The nature of that safety net varies, depending on the particular legal jurisdiction where the businesses are located. Global providers in the FinTech arena can be mobile and nimble and must choose their home country for these purposes carefully. The U.K. has leading-edge regulators, world class courts, a liberal regulatory landscape and a predictable legal system, based on the “common law” precedent-based method which is preferred globally. As such, the U.K. is uniquely positioned to develop reliable and trustworthy FinTech services and to build … Read more

O’Melveny & Myers Discusses the Legal Challenges of NFTs

Non-Fungible Tokens, or NFTs, are big news these days. After an NFT for a piece of digital art by the artist Beeple (Mike Winkelmann) sold for $69 million in March 2021―making it the third-most expensive artwork by a living artist―businesses and their lawyers have been scrambling to understand the legal issues surrounding NFTs, not to mention the meaning and value proposition of this novel class of digital assets for online marketplaces and digital content developers.

An NFT is a unique digital asset. For example, NFTs can be associated with a blog post, a sports highlight, or in the … Read more

Shearman & Sterling Discusses Financial Regulators’ Request on How Firms Use AI

On March 29, the Federal Reserve Board, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the National Credit Union Administration (the “Federal Agencies”) issued a request for information (“RFI”) from financial institutions, trade associations, consumer groups, and other stakeholders on the financial industry’s use of artificial intelligence (“AI”). The RFI broadly seeks insight into the industry’s use of AI in the provision of financial services to customers and appropriate AI governance, risk management, and controls. While the RFI should not come as a surprise (for several years, regulators have … Read more

Latham & Watkins Provides Beginner’s Guide to NFTs

Earlier this month, a blockchain firm bought a US$95,000 print by the British street artist Banksy, only to burn it in a livestreamed video and re-sell it for US$380,000 as a virtual asset called a non-fungible token (NFT) — sparking a flurry of news around what may prove to be this year’s hottest crypto craze.

How did the Banksy sale work? The group explained that by removing the physical piece from existence and releasing the NFT as digital art, the value of the physical piece will be moved onto the NFT. This trend isn’t just setting the art world ablaze; … Read more

How Blockchain-Based Financial Markets Can Create Systemic Risks That Harm Lower-Income People

Blockchain-based platforms create exciting possibilities for financial inclusion: widespread ownership of deposit accounts and access to payments services. From a macro-level perspective, however, these platforms can aggravate systemic risks. Systemic instability, in turn, threatens financial inclusion and sustainability.

Sustainable finance, as used here, means continuously providing financial inclusion and access to credit. Emerging financial technologies, or fintech, such as cryptocurrencies and blockchain-based financing platforms, have potential to create access to banking services, investment possibilities, and capital for those currently underserved in these areas.

Yet blockchain-based financial activity has the potential to threaten market stability in two different ways. First, it … Read more

How the Covid-19 Pandemic Affected the Cryptocurrency Market

In our recent paper, we conducted an empirical analysis to test how the outbreak of the Covid-19 pandemic affected the market for cryptocurrencies (“cryptomarket”). One year into the pandemic, this market seems to have boomed. For instance, when the pandemic erupted, Bitcoin – the world’s first cryptocurrency – could be purchased for about $7,300. Today, the very same token costs more than $46,800 – a staggering 640 percent rise. Other leading cryptocurrencies (e.g. Ether), showed similar (or even greater) increases. However, this upward trend is not necessarily obvious from a theoretical standpoint, as there are several forces that might drive … Read more

Regulating Digital Currencies: Towards an Analytical Framework

In a new article, I examine the development and regulation of digital currencies, which are monetary currencies that are evidenced electronically. Large “wholesale” payments among businesses and financial institutions already occur electronically, and bitcoin has been with us for more than a decade. Three recent events, though, are prompting the development of a “retail” digital currency – one used by consumers as an alternative to cash.

First, the People’s Bank of China has been working on a retail digital currency since 2014. It now has trial runs going in four cities. Second, Facebook announced in 2019 that it will … Read more