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Nearly five years after the passage of the Dodd-Frank Act, regulators are beginning to question whether the cumulative effect of the rules authorized by the law are hurting market liquidity and if that could pose a systemic risk.
June 12 -
The U.S. financial system has weathered several external threats in the past year, but significant hazards remain, including the potential for cyberattacks and excessive concentration of risk in central counterparties, according to a report by the Financial Stability Oversight Council.
May 19 -
The controversial $50 billion-asset cutoff was one of a host of policy issues the Treasury secretary addressed before lawmakers on Tuesday.
March 17
WASHINGTON Treasury Secretary Jacob Lew downplayed concerns by House Republicans Wednesday that financial regulation is a key driver in spurring recent market volatility and a possible reduction in liquidity.
Lawmakers on both sides of the aisle cited worries about liquidity at a hearing to discuss the Financial Stability Oversight Council's annual report on market risk.
While Lew noted that regulators pointed to market structure and liquidity as an area to watch in an FSOC report released last month, he said financial regulation is not a root cause.
"I do not see a major impact in terms of broad liquidity," Lew told lawmakers at a House Financial Services Committee hearing. "But we are constantly looking at this question of liquidity. And we're open to asking the question as to what the impact of federal policy is I just think it's a mistake to start there."
Observers began looking more closely at concerns about market liquidity after major market swings in U.S. Treasuries and other securities in October. Some critics have blamed the Volcker Rule, a ban on proprietary trading, along with other Dodd-Frank Act regulations as contributing to the incident, though Lew has repeatedly denied the connection.
"There was no breakdown in Treasury markets on October 15. That's not something that's supported. There was no liquidity crisis," he said. "There was a moment. There was a blip. There were a lot of things going on. But we don't see any evidence that regulation contributed to that event."
Treasury Department officials are preparing to release an analysis of the Oct. 15 market event later this summer, Lew added.
The move comes as other regulators and industry officials have expressed increasing concern about liquidity.
"We don't have all the answers about the causes of this decline in market liquidity," Richard Berner, director of the Office of Financial Research, said earlier this month, citing the need for additional research on the issue.
Republicans at the hearing Wednesday pressed Lew repeatedly for details about the role financial regulation might play in affecting liquidity, growing frustrated when the Treasury Secretary tried to sidestep the issue to focus on other factors he deemed as more central.
"Are you unwilling to answer this question because the do-gooders who are looking for risk are actually the ones that are potentially creating the risk in the market?" said Rep. Sean Duffy, R-Wisc. "And if you tell us yes, this could be a cause of the lack of liquidity in the bond market, you have to look at yourself. You have to look at the regulatory regime that's taken place since the financial crisis and you don't want to admit that today."
Lew said there are "many factors that are at work right now that are having an impact on liquidity it's not my view that financial regulation is the principal thing that requires our attention."
He emphasized that the FSOC is looking closely at the role other factors, such as the economic cycle and high frequency trading, are having on the markets.
"We are at a point in the business cycle where we are seeing, naturally, a lot of volatility as we move out of the deepest recession since the Great Depression. We're seeing an expectation of some movement in interest rates," he said. "We're seeing market structure changing rapidly. We're seeing the introduction of a high level of electronic trading, including high frequency trading, that's changing the structure of markets. We've also seen a tremendous increase in the volume of issuance of bonds."
Democrats also raised questions about market liquidity and the events of Oct. 15, though they focused less on whether Dodd-Frank was a central cause.
"I don't think we have any definitive answers yet, but I think it's an incredibly important issue," said Rep. Carolyn Maloney, D-N.Y., adding that she agreed with Lew that the trading volatility on Oct. 15 did not represent a "breakdown."
"Trading was continuous and trading volume was heavy so was it really a lack of liquidity driving the wild price swings or was it something else?" she said.
Separately, the New York lawmaker commended the FSOC for releasing over 1,400 pages of documents to the banking panel regarding regulators' designation of systemically important nonbanks, including several insurance companies. Lawmakers on both sides of the aisle had complained that the designation process was not sufficiently transparent.
Randall DeValk, acting assistant secretary for legislative affairs at the Treasury Department, notified the committee that FSOC would provide its written explanations about the designations to lawmakers in a June 9 letter to Rep. Jeb Hensarling, R-Texas, chairman of the banking panel.
"The council has provided substantial information to the public about its process for designating nonbank financial companies, and we are now making available to the committee over a thousand pages of documents detailing the council's evaluation of specific companies," the letter says.
