Davis Polk Discusses FSOC’s Shift to an Activities-Based Approach

The Financial Stability Oversight Council’s (FSOC) recently revised guidelines (the 2019 Guidelines)[1] on how it will identify and address financial stability risks are a major shift from the guidelines it issued in the immediate aftermath of the Financial Crisis (the 2012 Guidelines).  The 2019 Guidelines draw upon lessons learned from FSOC’s ultimately fruitless attempts to designate nonbank financial companies as systematically important.  Instead, building on one of the original purposes of the Dodd-Frank Act,[2] which was then emphasized in one of the Treasury Reports, the 2019 Guidelines focus on identifying and regulating systemically important … Read more

Wachtell Lipton Offers Acquisition Financing Year in Review: The Decade of Debt

2019 was another strong year for corporate borrowers, continuing a decade-long run marked by historically low interest rates and strong credit markets.  Over the last 10 years, total U.S. corporate bonds outstanding rose from $6 trillion to nearly $10 trillion, while leveraged loans expanded to $1.2 trillion from $500 billion.

But even in the midst of this bull market, new opportunities and challenges arose.  Two major trends from the last year stand out—the increased participation of “non-traditional lenders” as a financing source and the continued evolution of “debt default activism” as a material concern for borrowers.

The Acquisition Financing Markets

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Artificial Intelligence, Finance, and the Law

The progress and promise realized and presented by artificial intelligence in finance has been remarkable.  It has made finance cheaper, faster, larger, more accessible, more profitable, and more efficient in many ways.  Yet for all the significant progress and promise made possible by financial artificial intelligence, it also presents serious risks and limitations.

My recent article, Artificial Intelligence, Finance, and the Law, in the Fordham Law Review, offers a study of those risks and limitations – the ways artificial intelligence and misunderstandings of it can harm and hinder law, finance, and society.  It provides a broad examination of inherent … Read more

The Future of the Large Law Firm: Growth, Mergers, and Inequality

By last count, there are now 29 U.S. law firms with at least 1,000 lawyers.[1]  In a few weeks, this number should rise to 32, primarily as the result of mergers.[2] My prediction is that this number will climb to well over 50 by the end of this decade. Still, two inconsistent trends are peaking at the same time: (1) large firms are growing in size, but (2) growth in the number of equity partners at these firms has stalled (and may even have declined). According to the annual survey by the National Law Journal, the number of … Read more

Sullivan & Cromwell Discusses FSOC Changes to Nonbank SIFI-Designation Guidance

On December 4, 2019, the Financial Stability Oversight Council (the “Council”) voted unanimously to finalize amendments to its interpretive guidance (the “Final Guidance”) on designating nonbank financial companies as “systemically important financial institutions” (“SIFIs”).[1] The Final Guidance, which will replace the Council’s interpretive guidance on SIFI designations issued in April 2012 (the “Prior Guidance”),[2] implements an “activities-based” approach to identifying and addressing potential risks to financial stability, and is intended to enhance the “analytical rigor and transparency” of the Council’s process for designating SIFIs.

The Final Guidance, which adopts the … Read more

Do Private Equity Managers Raise Funds on (Sur)real Returns?

The private equity industry has become the target of calls for more regulation, with critics and academics concerned that net asset values (NAVs) are inflated around periods of fundraising, particularly in the case of low-reputation funds. These calls are predicated on only one possible explanation for performance peaks at the time a new fund is raised: agency problems caused by strategic performance manipulation (see, e.g., Jenkinson, Sousa, and Stucke 2013, Barber and Yasuda 2017, Chakraborty and Ewens 2018, and Brown, Gredil, and Kaplan 2019).  Yet there is an alternative explanation. Private equity fund managers can use the heterogeneity in performance … Read more

Reaching for Yield and the Diabolic Loop in a Monetary Union

One of the repercussions of the housing market collapse in the U.S. in 2007 was global anxiety about excess leverage, debt repayment, and overall credit conditions. Risk-pricing levels increased abruptly for highly indebted countries, making new borrowing to refinance debt increasingly difficult. Next year marks a decade since the eruption of the Eurozone sovereign debt crisis, when Greece, Italy, Ireland, Portugal, and Spain, known as the GIIPS countries, experienced an unprecedented rise in their borrowing rates.

For example, Greece and Ireland in 2010 ran an unprecedented peace-time deficit, reaching 15.8 percent and 32 percent of GDP, respectively. The Irish government … Read more

Insider Trading and Macroeconomic Risk

In a new article, I use network theory to show that there is a hidden link between insider trading and macroeconomic risk.  I suggest that current laws on insider trading increase the level of macroeconomic risk for the economy, and I show that this problem can be addressed by banning what I call network trades: trades based on private material information in firms that are connected to the firm of the insider (e.g. suppliers and competitors).

We live in an interconnected economy where private material information about one firm is also a relevant predictor of the performance of connected firms … Read more

Fed Governor Discusses Why Climate Change Matters for Monetary Policy and Financial Stability

I want to thank my colleagues at the Federal Reserve Bank of San Francisco, especially Mary Daly, Galina Hale, Òscar Jordà, and Glenn Rudebusch, for organizing this research conference.1 The presentations today provide important insights into the many important ways climate-related risks may affect our financial system and broader economy.2

Similar to many areas around the country, we need not look far from here to see the potentially devastating effects of our changing climate. Less than a hundred miles from here, families have lost their homes and businesses, and entire communities have been devastated by the Kincade fire.

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Stablecoins in Cryptoeconomics: From Initial Coin Offerings to Central Bank Digital Currencies

In a recent article, I highlight the links among initial coin offerings (ICOs), cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs).  Although these entities exist in different contexts (securities law and capital formation, payment systems, monetary policy), they are intertwined and share an evolutionary process.

ICOs raise issues related to securities law because digital tokens are tokenized equities and, therefore, securities. At the same time, they have increased the amount of outstanding cryptocurrencies and, as a result, highlighted the problems generally associated with money, in the context of cryptocurrencies.

Cryptocurrencies, including Bitcoin, have suffered tremendous volatility, impairing their role as … Read more

Improving Economic Policies for the American Territories

On October 15, 2019, the U.S. Supreme Court heard oral arguments in Financial Oversight and Management Board for Puerto Rico v. Aurelius Investment, a case that centers on the constitutionality of the appointment process for the members of the federally established board charged with restructuring Puerto Rico’s over $100 billion in debt.  In addition to shedding light on this narrow question about debt, bankruptcy, and the U.S. Constitution, the case highlights the larger, longstanding political and economic plight of over 4 million Americans living in the unincorporated territories of the United States (the “Territories”): Puerto Rico, Guam, American Samoa, … Read more

Welcome to Vilnius: Regulatory Competition in the EU Market for E-Money

If you google “Lithuania e-money,” the auto-fill function will suggest that you search for ”Lithuania e-money license.” If you accept the tip, the first result will be Ecovis, which describes itself as “the most experienced finance institution and FinTech licensing advisor” for Lithuanian licenses. The second Google result is SB-SB Legal Services, which has a more global reach and boasts of being “capable of proposing a wide choice of countries suitable for the registration of payment systems. We offer electronic money licenses in European countries, including Lithuania, Malta, Czech Republic, Cyprus, Estonia, Bulgaria, Switzerland, Great Britain and Gibraltar,” in addition … Read more

Does Litigation Encourage or Deter Real Earnings Management?

Securities class actions may deter financial misreporting and flawed disclosure, but how effective are they at deterring managers from taking actions that sacrifice long-term value for higher profits? In a recent paper, we uncover a novel mechanism that extends the disciplining effect of litigation to such managerial actions, often referred to as real earnings management (REM).

Real earnings management differs from accrual earnings management, in which managers cook the books to overstate earnings, in that REM does not violate financial reporting rules. Instead, it allows managers to report higher profits in the short run via real choices that boost short-term … Read more

Corporate Behavior and the Tax Cuts and Jobs Act

How has the U.S. Tax Cuts and Jobs Act of 2017 changed corporate behavior? In addition to reducing the corporate income tax rate to a flat 21 percent from a high of 35 percent, the TCJA changed other important rules on earnings stripping, expensing and depreciating, net operating losses, and the taxation of foreign subsidiaries. These changes generally reduced the effective and marginal tax rates of U.S. corporations. Using the first set of post-TCJA 10-K reports, our analysis seeks to provide a preliminary assessment of the extent to which these benefits have motivated corporations to do what TCJA proponents hoped.… Read more

Exequity Discusses Valuing Amazon

It is widely accepted among investors that compensation committees should align executive pay with performance in part by using incentive metrics that contribute directly to shareholder value. For this reason, it is common for incentive metrics to overlap with performance highlights relayed in press releases communicating quarterly earnings. Planting its latest performance measurement flag in the ground, Institutional Shareholder Services (ISS) introduced economic value added (EVA), contending that EVA is better than commonly used metrics such as EBITDA, EPS, and others. Compensation committees may wonder, is EVA really a better gauge of value than their earnings release metrics? Does ISS … Read more

Discontinuation of LIBOR

Global financial markets are preparing for the phasing out of the London interbank offered rate, or LIBOR, with the loan, derivatives, securities, and bond markets most affected.  As of mid-2018, about $400 trillion worth of financial contracts referenced LIBOR in one of the major currencies.[1] Supervisory pressure on the financial sector to reduce LIBOR inventories suggests that firms must embrace Risk Free Rates (RFRs) across LIBOR portfolios. The transition presents a multitude of challenges.

Why Use Benchmarks?

Financial market participants rely on benchmarks primarily to reduce asymmetric information about  the value of the traded financial instrument underlying the benchmark … Read more

Stock Repurchases and the 2017 Tax Cuts and Jobs Act   

On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA), which is the largest gross tax cut in American history (cutting more than $5.5 trillion in taxes over 10 years); the act took effect on January 1, 2018. The TCJA has two key elements: (i) a reduction in the corporate income tax rate from 35 percent to 21 percent, and (ii) a one-time tax holiday that cuts the tax on cash repatriation from foreign subsidiaries from 35 percent to 15.5 percent. Furthermore, in connection with (ii), the U.S. corporate tax system also moved from a worldwide … Read more

White & Case Discusses Cannabis Banking Bill’s Implications for Financial Services

On September 25, 2019, the US House of Representatives (“House”) passed, by a vote of 321 to 103, the Secure and Fair Enforcement Banking Act (“SAFE Banking Act”), bipartisan legislation designed to secure and regulate banking services to the expanding cannabis market in the United States. The SAFE Banking Act would bar federal regulators and prosecutors from penalizing banks and credit unions for providing core banking services to cannabis-related businesses (“CRBs”) and ancillary businesses authorized under state law. As the first standalone cannabis reform bill to pass either chamber of Congress, its passage in the House represents a major step … Read more

The Valuation and Governance Bubbles of Silicon Valley

The rise and fall of The We Company IPO bubble is one of those events that, like the subprime mortgage bubble that preceded the financial crisis, calls for an examination of market structures that could have produced such a precipitous turnabout.  Indeed, the two bubbles share similar features, namely, structural features that favor the expression of positive sentiments and make it difficult to express negative sentiments.  We call this “one-sided market sentiment.”

Some of the most famous moments of the financial crisis, memorialized in print and film, turned on how intrepid traders determined that impenetrably complex mortgage-backed securities were overvalued … Read more

The Seller’s Curse and IPO Pricing

Benchmark Capital partner and legendary tech investor Bill Gurley recently declared on CNBC, “It took me two decades to figure this out, but I think Silicon Valley’s been on the bad end of a bad joke for about four decades now, in terms of the way the traditional IPO process works.” He and others believe that direct listings, like the ones recently completed by Spotify and Slack, are friendlier to issuers.

The core of Gurley’s concern is that the traditional IPO process yields unfavorable pricing outcomes for issuers. On average since 1980, the stock price of IPO firms has popped … Read more