Finance & Economics

Economic and Normative Implications of Algorithmic Credit Scoring

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Commercial use of artificial intelligence (AI) is accelerating and transforming nearly every economic, social, and political domain. Yet, academic commentary on algorithmic decision-making in financial services has warned that historical data could result in biased algorithmic tools.[1] Bias, among other risks, is an essential consideration. However, there is a gap in recent literature on the potential optimal outcomes if risks are mitigated. Algorithmic credit scoring can significantly improve banks’ assessment of consumers and credit risk, especially for previously marginalized consumers. It is, therefore, helpful to examine the commercial considerations often discussed in isolation from potential normative risks.

In a … Read more

Fed, FDIC, OCC Jointly Warn Banks About Crypto-Asset Risks

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The Board of Governors of the Federal Reserve System (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) (collectively, the agencies) are issuing the following statement on crypto-asset1 risks to banking organizations.

The events of the past year have been marked by significant volatility and the exposure of vulnerabilities in the crypto-asset sector. These events highlight a number of key risks associated with crypto-assets and crypto-asset sector participants that banking organizations should be aware of, including:

  • Risk of fraud and scams among crypto-asset sector participants.
  • Legal uncertainties related to custody practices,

… Read more

Debevoise Discusses Treasury Guidance on Corporate Minimum Tax and Tax on Stock Buybacks

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On December 27, 2022, Treasury released Notices 2023-7 and 2023-2 (the “Notices”). The Notices provide initial guidance on the 15% corporate minimum tax on the book income of large corporations (the “CAMT”) and the non-deductible 1% excise tax on certain corporate stock buybacks by publicly traded companies (the “Buyback Tax”) that were included in the Inflation Reduction Act (the “IRA”).[1] The CAMT and the Buyback Tax both are effective January 1, 2023. The CAMT Notice provides immediate guidance on time-sensitive areas of uncertainty, such as tax-free transactions that may give rise to financial statement income, and requests comments on … Read more

ISS Discusses ESGF Rating as a Measure of Investing Quality

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Investors routinely consider both the ESG quality (i.e., the quality of a company’s management approach to environmental, social and governance (ESG) risks and opportunities) and the Financial quality (i.e., a company’s risk-adjusted profitability) of a firm in their day-to-day investment due diligence. Up until now the two have been looked at somewhat in isolation, however. Marrying the financial ‘F’ pillar with ESG performance can help create a more holistic approach to investing. This is exactly the use case for the new ISS ESGF solution.

The good management of long-term ESG risks may aid in the reduction of financial risks

… Read more

The FTX Collapse: Why Did Due Diligence, Regulation, and Governance Evaporate?

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FTX[1] is a Bahamas-based cryptocurrency exchange founded in 2019 that, at its peak in 2021, had over 1 million users, making it the world’s third largest crypto exchange by volume. Since November 11, 2022, though, FTX has been in bankruptcy, having borrowed extensively and used the assets of its clients in a likely and spectacular fraud.

Why did the capital-markets system fail to provide the checks and balances that investors count on, leaving the crypto market in the hands of operators hostile to regulation? How can we avoid a system beholden to Sam Bankman-Fried, Mark Zuckerberg, Elon Musk, and … Read more

Let’s Stop Treating Crypto Trading as If It Were Finance

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Members of Congress and financial regulators from the Federal Reserve, U.S. Treasury, SEC, CFTC, and CFPB appear set on regulating the crypto trading system (traded coins and associated marketplaces, exchanges, brokerages, lending, staking, derivatives, intermediaries, and enablers) as part of the traditional financial services system. Policy discourse on this topic has centered around which – rather than whether – financial regulators should be in charge of crypto trading. In advancing this view, Congress and the regulators appear to be following a path laid out by crypto companies seeking legitimacy through inclusion (on their own terms), in regulated finance.

Supporters of … Read more

Does Student Loan Forgiveness Have Significant Benefits for the Economy?

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Student loans are becoming a major challenge for the United States. An estimated 43 million borrowers owe about $1.6 trillion dollars, meaning a significant fraction of U.S. households is burdened with debt that is not dischargeable in bankruptcy. The problem has taken on increased political and economic significance since the Biden Administration announced a federal student-loan forgiveness program that opponents have criticized as a $400-billion social welfare program for the well-to-do.

In a new paper, we take a novel approach to student loan forgiveness by empirically exploring whether it has important economic benefits that could at least partially offset its … Read more

Sullivan & Cromwell Discusses Expiration of Legacy NAFTA Investor Protections

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In 2020, the United States-Mexico-Canada Agreement (“USMCA”) entered into force, replacing the 1994 North American Free Trade Agreement (“NAFTA”).  Both treaties include certain protections that the contracting states must afford to nationals of the other contracting states investing in their territory, and provide for arbitration as a forum to recover losses from breaches of those protections.  However, USMCA contains additional limitations and restrictions on foreign investors’ rights to pursue claims in arbitration for breach of the treaty’s terms.  Under Annex 14-C of USMCA, claims related to foreign investments established or acquired while NAFTA was in place (so-called “Legacy Investments”) may … Read more

Davis Polk Discusses FSOC Report on Financial Stability Risks of Digital Assets

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The report recently issued by the Financial Stability Oversight Council (FSOC) is quite different from the other reports published so far by the U.S. financial regulators in response to Executive Order 14067 on digital assets (FSOC Report).1 Helpfully, this report included a series of specific policy recommendations about what Congress and the regulators ought to do next. But the FSOC Report reveals a continuing lack of consensus and turf wars among the U.S. financial regulators, making its calls for coordination and cooperation ring hollow and introducing incoherence into some of the recommendations.

Following an exhaustive 60-page discussion of the … Read more

Rethinking the Value and Emission Implications of Green Bonds

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Sustainable investing implies that green assets entail low expected returns because (i) green investors relish holding them and (ii) such assets hedge climate risk by encouraging pro-environmental outcomes. In a new paper, we evaluate whether these predictions are supported by the data using a sample of green bonds. In the process, we investigate (i) whether green bonds are associated with significant returns for bondholders and equity investors, both at the time of issuance and after; and (ii) whether the carbon emissions of the issuers of green bonds fall post-issuance.

Green bonds represent a noteworthy asset class of their own. The … Read more

African Capital Markets: The Case of the Democratic Republic of Congo

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On June 21, 2021, the International Monetary Fund (IMF) weighed in on the economic situation in Africa, and the news was not good.

“African economies are at a pivotal juncture,” the IMF said. “The COVID-19 pandemic has brought economic activity to a standstill. Africa’s hard-won economic gains of the last two decades, critical in improving living standards, could be reversed. High public debt levels and the uncertain outlook for international aid limit the scope for growth through large public investment programs. The private sector will have to play more of a role in economic development if countries are to enjoy … Read more

How Corporate Managers Think about Forward-Looking Guidance

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Headlines during earnings season often focus on the forward-looking guidance corporate managers provide. Yet, questions remain about managers’ perceptions of the guidance process and the tradeoffs they face in deciding whether and what to guide. To gain greater insight, we surveyed 357 managers at publicly listed corporations and conducted nine in-depth interviews.

Our survey sheds light on the critical role guidance plays during earnings season. Because analysts and investors dislike surprises, our respondents said guidance provides an effective channel to manage expectations. Around earnings announcements, corporate managers commonly meet privately with analysts and investors after conference calls. Our respondents said … Read more

How the Rise of Corporate Debt in Emerging Economies Affects Corporate Investment

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In recent years the corporate debt landscape in emerging markets has changed substantially. Debt in emerging economies climbed to a record high of $55 trillion in 2018, illustrating the largest and fastest surge in the last five decades. In addition, according to the International Monetary Fund (IMF) 2015 report, the mean ratio of corporate debt to GDP grew by 26 percent. These recent developments are important and have raised broad concerns because emerging economies account for 60 percent of the global GDP.

High levels of leverage could either constrain or accelerate firm growth. In addition, high corporate debt … Read more

Finance Without Law: The Case of China

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In a new article. I investigate how two financial markets of trillions of dollars each have developed extralegally in the past two decades, creating risks of regulatory enforcement actions and contract defaults. More specifically, I examine (1) how Chinese internet companies from Sina to Alibaba have adopted the structure of a variable interest entity (“VIE”) both to circumvent the Chinese government’s ban on foreign capital in high-tech industries and to get listed on overseas stock markets, and (2) how Chinese entities and foreign investors contract out of China’s stringent regulations on the issuance of international bonds, focusing on one of … Read more

Machine Learning, Algorithmic Trading, and Manipulation

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Trading in financial markets is increasingly dominated by algorithms. They enable trading at speeds and levels of adaptiveness that are impossible for human beings. A key question for the legal system is whether these algorithms will disrupt the efficiency and integrity of markets, and if they will, whether existing regulation is well-suited to deterring misconduct. A key question for finance is to determine what market structures are most robust to manipulation by new algorithmic trading agents.

In our new working paper, we study the potential consequences of advanced algorithms trading in a financial market. Specifically, we analyze experimentally how … Read more

Argentina’s Cliffhanger Negotiations on a New Loan Deal with the IMF   

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In late March, Argentina and the IMF agreed on a new arrangement that would enable Argentina to avoid falling into arrears on the IMF’s 2018 loan. However, the agreement was reached only after protracted and tortuous negotiations that dragged on for at least 18 months and concluded only at the last minute before a de facto March deadline.

In a new two-part article, I discuss the many twists and turns of the process and review the major substantive policy differences between Argentina and the IMF as well as the political considerations involved in the negotiations.

In August 2020, Argentina restructured … Read more

How Common Are Negative First-Day IPO Returns?

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Investors generally expect companies to make a successful and profitable debut on the stock market with their initial public offering (IPO). However, some stock market launches fall short: The price of shares in Deliveroo’s $2.8 billion IPO in 2021, for example, fell by more than 26 percent when launched on the London Stock Exchange, and the price of Uber shares issued in its $75.46 billion IPO in 2019 dropped, 7.6 percent after their first day of trading on the New York Stock Exchange.

In 2021, around $143 billion worth of shares were issued in U.S. IPOs, but more than 25 … Read more

How to Move from Local to Global Regulation of Crypto-Assets

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On July 7, 2022, the U.S. Department of Treasury (USDT) published a fact-sheet on the regulation of digital assets(a.k.a. crypto-assets) in which it emphasized the need for global cooperation. However, this fact-sheet is only a drop in an ocean of mostly uncoordinated crypto-regulation initiatives, both domestically (e.g., presidential executive order, a bi-partisan bill submitted to Congress, and diligent SEC enforcement) and abroad (e.g., final steps toward a harmonized regulation in the EU and several declarations by individual countries).

The current wave of crypto-regulation announcements aims to eliminate the confusion that has dominated the cryptomarket since its emergence. In … Read more

Cleary Gottlieb Discusses Digital Asset Amendments to the UCC

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This month, the sponsors of the Uniform Commercial Code (“UCC”) approved wide-ranging amendments to the UCC (the “2022 UCC Amendments”)[1] to provide workable rules for emerging technologies, such as distributed ledger technology and virtual currency.  If adopted by individual state legislatures, these amendments should provide greater certainty regarding the rules governing security interests, competing claims, custodial risks, and other issues associated with digital assets.

The UCC is a uniform law sponsored by the American Law Institute (“ALI”) and the Uniform Laws Commission (the “ULC”) and governs various commercial transactions in personal property, including rules for granting and perfecting security … Read more

Skadden Discusses Senate Bill to Create Regulatory Structure for Crypto and Other Digital Assets

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In recent years, innovation in the blockchain or “Web3” space has been impacted by uncertainty on the regulatory front. Undoubtedly, the greatest area of uncertainty has involved the Securities Exchange Commission (SEC) and its application of the so-called Howey test when determining whether a cryptocurrency or other digital asset is being offered as an investment contract for purposes of applying U.S. securities law. Despite repeated calls for regulatory clarity from industry members, lawmakers and even SEC commissioners, little progress has been made in achieving that clarity.

Industry members have therefore increasingly come to the conclusion that a long-term solution will … Read more