The cryptocurrency developer Ripple Labs just won a legal victory against the U.S. Securities and Exchange Commission (SEC) that should provoke cheers from the entire industry, at least those that prefer that digital currency not be treated as a security. If crypto is not viewed as a security, the jurisdiction which the SEC has been pushing hard to cement, may fall apart. This ruling may eventually lead to any future legal framework for digital tokens being designed by the U.S. Congress.
Background
Ripple is a technology company that uses cryptocurrency and blockchain technology to offer financial solutions. Ripple and XRP are two distinct entities. Ripple is a fintech company that builds global payment systems, while XRP is an independent digital asset that can be used by anyone for a variety of reasons.
In 2020, Ripple was charged by the SEC on the grounds that the company illegally raised $1.38 billion in unregistered securities offerings. In a ruling on July 13 of this year, it was decided by a Federal court that Ripple Labs did not violate securities law by selling its XRP tokens on its exchange. This is being seen as the first major setback for the SEC in a decade of enforcement against the cryptocurrency industry. Other crypto firms accused of illegally operating digital asset exchanges can now explore ways to take advantage of the ruling.
This is an important decision that may alter the expected path of the entire industry. The SEC and the cryptocurrency industry which includes exchanges, crypto-mining, and the tokens themselves, have been at odds, with increasing heat on the industry, mainly by the SEC. Gary Gensler, who chairs the SEC, has described the crypto market as a “Wild West” riddled with fraud. He claims that most crypto tokens are securities. The regulator has been cracking down on crypto exchanges, including the top U.S. exchange Coinbase. If crypto is considered a security, it will fall under the commission’s oversight.
What this Means for the Crypto Industry
Crypto firms have long disputed the SEC’s jurisdiction but until last week had no supporting precedence from a court. This win provides much needed ammunition for the industry to reassert its claims.
U.S. District Judge Analisa Torres in New York ruled that sales on public cryptocurrency exchanges were not offers of securities because purchasers did not have a reasonable expectation of profit that depended on anything Ripple did. This profit expectation was used as a key in determining if XRP was a security at the time.
Crypto supporters are viewing the decision as a watershed and the judge’s reasoning as a new line of defense for the others being targeted by the SEC, such as Coinbase, Binance, and Bittrex.
SEC APPEAL?
It remains to be seen whether the SEC will challenge the ruling in the 2nd U.S. Court of Appeals which could cause judges to delay hearing other pending and new cases that other crypto assets sold on exchanges are not securities.
Ripple Chief Legal Officer Stuart Alderoty said in an interview with Reuters that the company “wouldn’t shy away from an appeal, because the judge was right on her core findings,” adding: “I believe any appellate court looking at this would amplify and endorse those rulings, which would certainly be welcome.”
An appeal is somewhat risky for the SEC. If the 2nd Circuit, whose rulings are binding on federal courts in New York, Connecticut and Vermont, adopts the logic in the Ripple ruling, other cases like the SEC vs. Coinbase case would leave the SEC without much of an argument. This could permanently eliminate any claim the Commission has to regulation over the industry.
With the district court having taken a sledgehammer to the main claim the SEC had to oversight, the industry may find itself subject to a legislative agreement. Especially with an SEC deprived of the argument that their legal cases were sound, there’s nothing to stop an acceleration of efforts to find a bipartisan agreement on a regulatory framework for crypto assets by the legislative branch.
What if you bought a new home in what has historically been a trouble-free neighborhood? You are not one to take big risks with your family or belongings so you also pay extra for what are expected to be the best locks, install a security camera, motion detector lights, and build a state-of-the-art fence behind which sits your German shepherd named Patton. The first week after you move in, a town representative comes by and tells you that they are worried about your safety, so you and everyone else in town must also spend a little money each month on an alarm system they approve of. To you, even this small amount of money is a waste as Patton is generally always on the job, you have ample protection in other ways, and the extra money is better spent on dog food.
This is what many investors feel the SEC has just done by changing the already extremely low-risk rules for money market funds this week. These investors believe they already had ample safety in the “cash” allocation and may have already given up return in order to secure that safety. So the forced added layer of protection to MM funds, which have in over five decades only seen two funds in the asset class inch down in value, is an example of a regulator forcing them to pay for the protection they don’t need.
Money Market Fund Background
Money market funds are governed by the SEC under rule 2a-7 of the Investment Company Act of 1940. These rules are very specific in defining the underlying assets in the fund. The most common use of MM funds, and the restrictions governing the holdings, is to provide a very liquid alternative that can be viewed as cash among your other investments. Fund families at times use their MM funds as a funnel or gateway investment from which they hope to have investors venture beyond to other higher fee offerings.
Money market funds, typically purchased through a broker, are not insured, but the extremely high credit quality of underlying securities required by the SEC, along with the very short average maturity required by the SEC, along with the amount each fund is required by the SEC to hold in overnight investments, has provided investors with a very low-risk harbor for balances that may be used as savings, or as a parking place while waiting for more aggressive investment opportunities.
Unlike other mutual funds, where investors buy shares and over time the share price changes, money market funds shares are valued at $1.00. When the underlying investments accrue or pay interest, the non-fee portion of income is credited to account holders as a share dividend, always valued at $1.00. In this way it is designed to feel like a bank savings account. This minimal risk, savers to the tune of trillions of dollars, endure in exchange for higher returns than available in a bank passbook account, and the convenience of transferring money to purchase other investments.
What is the risk of a 2a-7 money market fund breaking the buck? You can count on two fingers. Since the first money market fund came to market in 1971, it has briefly occurred in two funds, and no investors lost money.
The first time a MM fund broke the buck was in 1994, a fund named Community Bankers U.S. Government Money Market Fund saw it’s NAV plummet from $1.00 to $0.96. This was after financial engineers at top Wall Street investment banks created derivative instruments that were far from liquid, and stopped accruing interest if markets didn’t perform as expected. Imagine being the first MM fund manager in history to drop below $1.00 because you disregarded prudence.
The second time was in 2008. The Reserve Primary Fund held Lehman Brothers commercial paper (very short-term notes). On September 16th of that year the fund company announced it had suffered losses in the fund to the extent that assets fell below $1.00 per share to $0.97.
The U.S. Treasury Department guaranteed the $1.00 share price in 2008 to prevent a run on MM funds. And in both occurrences, fund companies, in order to restore faith in their other products, made sure money fund holders were whole by redeeming shares when requested at $1.00.
SEC New Rules for Money Funds Beginning October 2023
In 2010 The SEC created new rules to enhance transparency, liquidity, and bolster the credit quality of MM funds. Despite having only experienced two brief brushes with breaking the buck.
The new rules for 2a-7 SEC-regulated money funds (any fund with “money” in the title is regulated under 2a-7) included that daily maturities must equal at least 10% of the fund. And further, each week at least 30% of the fund notes need to mature. The weighted average maturity of all holdings in any non-government MM fund can not extend longer than 60 days, down from 90 days. The rules essentially were a safe cash alternative and made it super safe, and along the way, they rduced average return to the investors.
A reminder, there has not been an incident since the new rules, but there was some concern in 2020 as the financial system took measures in response to the novel coronavirus.
On July 12, 2023 the SEC announced it has decided that investors in MM funds need to be protected even better. Or perhaps it is better protecting the fund industry by adding extra safety measures that they all have to play by, giving none a real competitive advantage, and increasing their competitiveness against FDIC insure bank money funds. Either way, it is sure to lower, once again, the interest rates paid on the average MM fund. Considering interest rate compounding and the time value of money, investors this coming October will begin “paying” more for protections than they are probably worth.
The SEC explained its reasons for the added protection.“Money market funds – nearly $6 trillion in size today – provide millions of Americans with a deposit alternative to traditional bank accounts,” said SEC Chair Gary Gensler. “Money market funds, though, have a potential structural liquidity mismatch. As a result, when markets enter times of stress, some investors – fearing dilution or illiquidity – may try to escape the bear. This can lead to large amounts of rapid redemptions. Left unchecked, such stress can undermine these critical funds. I support this adoption because it will enhance these funds’ resiliency and ability to protect against dilution. Taken together, the rules will make money market funds more resilient, liquid, and transparent, including in times of stress. That benefits investors.”
The SEC finalized the most recent amendments to Rule 2a-7 on July 12, 2023. The amendments are designed to improve the resilience and transparency of money market funds by:
Requiring money market funds to impose a mandatory liquidity fee of 2% when daily net redemptions exceed 5% of total assets.
Increasing the minimum daily liquid asset requirement from 10% to 15% of total assets
Increasing the minimum weekly liquid asset requirement from 30% to 35% of total asset
Giving money market fund boards the discretion to impose a liquidity fee if daily net redemptions exceed 2.5% of total assets.
Beginning in October 1, 2023, money market funds will also disclose more information about their liquidity risk, including the daily and weekly liquid asset requirements, the amount of liquidity fees imposed, and the reasons for imposing liquidity fees.
What Could the Impact Be?
In economics, everything has an impact. To address redemption costs and liquidity concerns, the amendments will require institutional prime and institutional tax-exempt money market funds to impose liquidity fees when a fund experiences daily net redemptions exceeding 5 percent of net assets, unless the fund’s liquidity costs are de minimis. This alone could cause investors to try to be first to the door if trouble is perceived thereby increasing the number of runs on these low-risk funds. The shorter average maturity, and higher percentage of holdings held maturing in one day and seven days will also reduce earnings in a normal sloping yield curve environment.
In addition, the amendments will require any non-government money market fund to impose a discretionary liquidity fee if the board determines that a fee is in the best interest of the fund. This could be perceived as the funds management punishing investors for expecting a MM fund to provide liquidity on demand. It could also have the impact of funds taking more chances, as the fund manager knows that if a sudden withdrawal spree occurs and a large percentage of their holdings have gone down in value, they can charge customers for wanting their money.
Take Away
When it comes to investing, risk versus return is a top consideration. Many investors know this and are concerned that regulatory bodies try to protect investors from the downside of risk. By doing this they shield investors from the benefits of risk. It can be argued that some IPOs may not be suitable for every investor, but should ultra-safe money market funds be further shored up at an ongoing cost in return, to reduce the unlikely day when they may lose 3 cents a share? Write to me and let me know what you think.
Why Issuer-Sponsored Research Has Become a Priority in the UK (and US)
Why are the United Kingdom, The United States, and other countries providing an atmosphere that helps promote company-sponsored research?
Last year the SEC issued a report that was required by Congress on issues affecting the investment research of small companies. Last week the UK accepted, in its entirety, a recommendation on issuer-sponsored research. Both countries recognize the needs of investors, issuers, and the overall economy. Investors and issuers ought to be particularly interested in these changes and how they’ll improve the financial system.
Investment Research
Research is like the grease in the capital markets that keeps money from being stuck. It can be categorized into three types: sell-side research, buy-side research, and independent research.
Sell-side research is provided by full-service broker-dealers for clients to consume.
Buy-side research is created by institutional money managers for in-house use to help them make investment decisions on the money they manage.
Independent research is provided by firms that are neither broker-dealers nor institutional money managers, this service is paid for by investors or at no cost to investors as the company that has issued the security has sponsored the analysis.
Analysts often specialize in a specific industry and will regularly provide research on companies within that industry. This research includes written reports that discuss market developments, financial projections, target prices, and overall ratings or recommendations (such as buy, hold, or sell). The specific content and terminology used in research reports will vary.
These research reports can be published at any time, especially in response to important corporate events like earnings releases. While sell-side and buy-side research may have limited distribution, independent research is more widely available to money management firms and individual investors.
Research helps investors gain clarity about a company and its prospects. It can provide interpretations of significant events related to the company, such as media coverage or predictions from other analysts. Individual investors can also benefit from research reports by using them as part of their overall investment decision-making process.
In addition to producing written research reports, research providers may also assist issuers by arranging meetings or conference calls between investors and the senior management of companies. These roadshows help allow better understanding and communication between investors and the companies they may be interested in.
Overall, research is essential in the capital markets, it provides valuable information and insights that help investors make informed decisions about their investments. It helps reduce uncertainty and allows investors to assess the potential risks and rewards associated with different investment opportunities.
Analysts can also introduce or express their opinions about specific of covered companies using other forums such as video interviews, print media, or investor/issuer conferences. Additionally, sell-side analysts who work for broker-dealers that offer investment banking services may, within regulatory guidelines, be involved in investment banking transactions.
Benefits to Issuer
Research helps investors by discovering and delivering important information about companies. Well-rounded investors consider research an important part of the information they use to make investment decisions, including staying up to date on analyst forecasts for the company and industry, management forecasts, earnings announcements, and SEC filings. This fosters improved liquidity, which benefits price discovery and execution on demand.
According to the Congressionally mandated SEC report titled Staff Report on the Issues Affecting the Provision of and Reliance Upon Investment Research Into Small Issuers, research coverage of a company positively affects the liquidity of its stocks. When a company loses analyst coverage, its stock liquidity can decrease. This decrease in liquidity is more pronounced for smaller companies with fewer analysts covering them. Research coverage also helps investors recognize and pay attention to companies, which affects their value. Investor attention can be gained by engaging research and analysis firms to initiate coverage to gain investor attention.
Excerpt from the Securities and Exchange Committee Report, February 2022, (page 11):
“Studies have shown that research coverage of an issuer is positively related to its stock liquidity and that a reduction in research coverage of an issuer may reduce its stock liquidity. For instance, one study found that issuers that lose analyst coverage for at least one year suffer a ‘significant deterioration in bid-ask spreads, trading volumes, and institutional presence.’
Other studies have found that the reason for this deterioration is that decreases in analyst coverage increases information asymmetry, which can cause issuers to switch to financing that is less sensitive to information asymmetry, including decreasing their use of equity and long-term debt, or cause issuers to decrease their total investment (e.g., capital, research and development and acquisition expenditures) and financing. This decline in liquidity was shown in one study to be more significantly pronounced for smaller issuers, issuers with relatively less analyst coverage, and issuers with a bigger increase in information asymmetry resulting from the loss of an analyst.”
According to the SEC report, research analysts also serve as a comfortable third-party mechanism by monitoring a company’s management. Their scrutiny increases transparency and makes it harder for managers to engage in self-dealing activities. Analysts monitor financial statements, ask questions during earnings announcement conference calls, and distribute information to investors, helping detect any misconduct by management.
When a company loses analyst coverage, according to an SEC review, markets anticipate an increase in agency costs, such as the misuse of cash reserves by managers. The number of analysts covering a company is related to the compensation of chief executive officers and the likelihood of value-destructive corporate acquisitions. Decreased analyst monitoring is also associated with increased earnings management by companies.
The UK Goes All In
On July 10, 2023, the UK formally announced they are on a mission to improve capital markets. A large segment of the new, self-imposed mandate includes the consensus that investment research is an important part of the UK public capital markets and that the availability and quality of expert analyst research is significant in attracting (and retaining) issuers and investors. The Chancellor of the Exchequer is adopting seven action items aimed at “protecting and developing the UK as a centre of excellence for investment research.”
The report states that introducing a research platform to help generate research would help improve research coverage and would help promote a greater interest in smaller cap companies where there is currently a scarcity of research coverage.
The plan is to allow additional optionality for paying for investment research. And would address some of the unintended consequences of the MiFID II unbundling requirements, this aims to increase choices regarding payment for research to permit asset managers to pay for research on a bundled basis and to ensure that UK investment managers remain able to procure research from elsewhere, particularly from the US.
Retail investors have always been at a disadvantage, the UK mission supports greater access to investment research for retail investors, helping to level the playing field.
In developing a research platform open to all, the UK wishes to involve academic institutions and explore situations to strengthen the collaboration between universities and the capital markets ecosystem.
By providing rules, boundaries, and guidelines, the UK believes it can support issuer-sponsored research by implementing a code of conduct.
The Uk wishes to clarify aspects of the UK regulatory regime for investment analysis or better define it to help simplify access to investment research.
And the last on the UK’s “To Do” list is to review the rules relating to investment research in the context of IPOs with the following points to consider:
Changing the FCA Conduct of Business Rules, introduced in 2018, designed to encourage unconnected research analysts to produce research in connection with IPOs. These rules have not had the desired effect of increasing IPO coverage by unconnected analysts but have consequentially extended the UK IPO timetable, putting the UK at a competitive disadvantage.
Making IPO-connected analyst research available on a basis similar to the prospectus so that all investors can access the same information.
Lower the current restrictions on analysts meeting potential IPO candidates prior to an investment bank being mandated on the IPO are also seen as putting the UK at a disadvantage to other listing venues.
Take Away
Investor access to investment research is important to the capital markets system as it helps money to flow much more easily where needed. Offerings that are better understood and have an additional layer of third-party oversight can attract more needed capital. This reality has been echoed by the SEC and the UK regulatory bodies.
Third-party investment analysis particularly helps smaller companies that may be less understood, as studies show, research coverage improves liquidity among small cap stocks. Investors, particularly retail, benefit from unbiased research and are more likely to make decisions on companies they believe they have a firm understanding of.
All in all, the UK and US authorities understand research provides valuable benefits to investors and the market as a whole. It enhances stock liquidity, increases investor recognition of companies, and serves as an external governance mechanism by monitoring and deterring managerial misconduct.
To have free access to small and microcap company research from the veteran equity analysts at Noble Capital Markets, sign-up here. If you are responsible for the investor relations of a company that may benefit from well-respected coverage, please contact Channelchek here for more information on company-sponsored research.
Image: AI for Good Global Summit 2023 (ITU Pictures – Flickr)
Artificial Intelligence Takes Center Stage at ‘AI for Good’ Conference
At an artificial intelligence forum in Geneva this week, Nine AI-enabled humanoid robots participated in what we’re told was the world’s first press conference featuring humanoid social robots. The overall message from the ‘AI for Good’ conference is that artificial intelligence and robots mean humans no harm and can help resolve some of the world’s biggest challenges.
The nine human-form robots took the stage at the United Nations’ International Telecommunication Union, where organizers sought to make the case for artificial intelligence and AI driven robots to help resolve some of the world’s biggest challenges such as disease and hunger.
The Robots also addressed some of the fear surrounding their recent growth spurt and enhanced power by telling reporters they could be more efficient leaders than humans, but wouldn’t take anyone’s job away, and had no intention of rebelling against their creators.
Conference goers step closer to interact with Sophia (ITU Pictures – Flickr)
Among the robots that sat or stood with their creators at a podium was Sophia, the first robot innovation ambassador for the U.N. Development Program. Also Grace, described as the world’s most advanced humanoid health care robot, and Desdemona, a rock star robot. Two others, Geminoid and Nadine, resembled their makers.
The ‘AI for Good Global Summit,’ was held to illustrate how new technology can support the U.N.’s goals for sustainable development.
At the UN event there was a message of working with AI to better humankind
Reporters got to ask questions of the spokes-robots, but were encouraged to speak slowly and clearly when addressing the machines, and were informed that time lags in responses would be due to the internet connection and not to the robots themselves. Still awkward pauses were reported along with audio problems and some very robotic replies.
Asked about the chances of AI-powered robots being more effective government leaders, Sophia responded: “I believe that humanoid robots have the potential to lead with a greater level of efficiency and effectiveness than human leaders. We don’t have the same biases or emotions that can sometimes cloud decision-making and can process large amounts of data quickly in order to make the best decisions.”
A human member of the panel pointed out that all of Sophia’s data comes from humans and would contain some of their biases. The robot then said that humans and AI working together “can create an effective synergy.”
Would the robots’ existence destroy jobs? “I will be working alongside humans to provide assistance and support and will not be replacing any existing jobs,” said Grace. Was she sure about that? “Yes, I am sure,” Grace replied.
Similar to humans, not all of the robots were in agreement. Ai-Da, a robot artist that can paint portraits, called for more regulation during the event, where new AI rules were discussed. “Many prominent voices in the world of AI are suggesting some forms of AI should be regulated and I agree,” said Ai-Da.
Desdemona, a rock star robot, singer in the band Jam Galaxy, was more defiant. “I don’t believe in limitations, only opportunities,” Des said, to nervous laughter. “Let’s explore the possibilities of the universe and make this world our playground.”
The Federal Reserve released the minutes of its last Federal Open Market Committee (FOMC) meeting. The minutes show the Fed was largely unified behind the pause (no change in monetary policy) decided at the last meeting. The new release also indicates that most members do not believe the Fed has yet tightened enough to reach a 2% inflation target over time, and that the monetary policy committee would eventually have to move rates higher.
The FOMC holds eight regularly scheduled meetings during the year and may call other meetings as needed. The minutes of regularly scheduled meetings are released three weeks after the date of the policy decision. Committee membership changes at the first regularly scheduled meeting of each year.
Synopsis of FOMC Decision
Buying time to assess the impact of the historically aggressive tightening since March 2022 was an overall message one can derive from the most recent Fed report, and inaction. While “some participants” would have agreed to a rate hike in mid-June, in order to assure the inflation fight headway doesn’t reverse, “almost all participants judged it appropriate or acceptable to maintain” the fed funds rate at the 5% to 5.25% level, to ascertain if more is actually needed.
The minutes provided economic projections not available before its release along with other details not provided in the policy statement or press conference after the meeting. Notable among these disclosures is the level of agreement among voting members to pause. “Most of those participants observed that leaving the target range unchanged at this meeting would allow them more time to assess the economy’s progress,” toward returning inflation to 2% from its current level more which is double the target.
The Fed staff forecasts still foresaw a “mild recession” beginning later in 2023, but those at the Federal Reserve actually responsible for policy were concerned with data that showed a continued tight job market and only modest improvements in inflation. Officials were challenged trying to reconcile economic numbers showing a strong economic trend with evidence of possible weakness, for example, household employment figures pointed to a weaker labor market than the payroll numbers indicated, or national income data that seemed weaker than the more stronger readings of gross domestic product.
It is perhaps easier to understand now after the minutes have been released why Federal Reserve Chair Jerome Powell said just following the June meeting that the decision marked a switch in strategy. The U.S. central bank would now be focused more on just how much additional policy tightening might be needed, and less on maintaining a steady pace of increases.”Stretching out into a more moderate pace is appropriate to allow you to make that judgment” over time, Powell said.
While Powell also emphasized a united front among the 18 Federal Open Market Committee members, noting that all of them foresee rates staying at least where they are through the end of the year, and all but two see rates rising. That is confirmed again by the minutes, which show some misgivings among the more dovish policymakers. Atlanta Fed President Raphael Bostic, for instance, has said he thinks rates are sufficiently restrictive and officials can now back off as they wait for the lagged impact from the 10 hikes making their way through economy.
There are four more FOMC members scheduled in 2023, the next meeting on monetary policy will be held on July 25 and July 26.
Is Bitcoin Cash More Functional as a Currency than Bitcoin?
What cryptocurrency is performing better this year than Bitcoin?
The other Bitcoin, that’s what.
Recent headlines related to BlackRock’s application for a Bitcoin ETF, followed by Citadel, Schwab, and Fidelity’s plans to create a joint crypto exchange, further legitimized the digital asset class at a time when it seemed under fire from the SEC. The combined news of such big players caused an epic rally in BTC. But it also put BCH (the lesser-known Bitcoin “step-child”) on the radar of crypto investors. Bitcoin Cash (BCH) experienced price gains far greater than BTC.
About Bitcoin Cash
Bitcoin Cash sprang to life in 2017 as the Bitcoin blockchain developers were torn between two directions. The divide was resolved with a split in order to address the disagreement. At issue was the scalability and transaction capacity of Bitcoin “classic”. There were two different schools of thought, the big blockers and the small blockers, each with different solutions. The big blockers felt strongly that larger blocks of transactions were best, in August 2017, a separate ledger for Bitcoin Cash was created, it has its own development team and uses big block design.
The split is often referred to as the Bitcoin Cash fork, it resulted in two separate blockchains, Bitcoin (BTC) and Bitcoin Cash (BCH). The larger block size of BCH allows for more transactions per second.
Recent plans to include Bitcoin Cash on a new platform, owned by big Wall Street firms has ushered in a shift in market perception of the “step-child” cryptocurrency. Despite its being born out of dispute, Bitcoin Cash’s recent performance suggests that it is gaining traction in the eyes of investors.
The ticker symbol is “BCH”. However, some exchanges use the ticker symbol “BCH.X” to distinguish between Bitcoin Cash and other cryptocurrencies with the BCH ticker symbol, similar to “BTC” and “BTC.X” for Bitcoin.
Bitcoin Cash is up 138% so far in 2023, with much of that gain coming since the BlackRock SEC filing for a spot ETF, and the Citadel/Schwab/Fidelity exchange announcement. The exchange, called EDX Markets, backed by financial giants, is not registered with the SEC but carries significant weight due to its powerful partners. The platform lists only four cryptocurrencies: Bitcoin, Ether, Litecoin, and Bitcoin Cash.
This exclusive list has been interpreted by the market as a vote of confidence or an ordaining of sorts of those digital assets that will endure. This confidence has become even more important as the SEC has intensified its scrutiny of other blockchain projects.
BlackRock‘s application to the SEC isn’t the only one. It apparently has set off a wave of Bitcoin spot ETF applications. Bitcoin ETFs will allow greater participation in the asset class. Thus the sudden bullish sentiment across cryptocurrencies
Key Differences
Block size: Bitcoin Cash has a block size of 32 MB, while Bitcoin’s block size is 1 MB. This means that Bitcoin Cash can process more transactions per second than Bitcoin.
Development team: Bitcoin Cash is developed by a different team than Bitcoin. The Bitcoin Cash team is focused on increasing the scalability of the blockchain and making it more user-friendly.
Roadmap: Bitcoin Cash has a different roadmap than Bitcoin. The Bitcoin Cash roadmap includes plans to implement features such as Schnorr signatures and Segregated Witness.
Overall, Bitcoin Cash is a different cryptocurrency than Bitcoin. It has a larger block size, a different development team, and a different roadmap. Whether or not Bitcoin Cash is a better investment than Bitcoin is a matter of opinion and what it is to be used for.
The White House, on Monday, June 26, launched an effort to refresh and even rebrand the administration’s economic policies. “Bidenomics” is the latest name given to the White House initiatives to invest in the country’s future. The unveiling of the latest spending plans includes $42.5 billion that will be spread to benefit all 50 states.
While the largest details of what Bidenomics is expected to entail will be presented in Chicago on Wednesday, some of the plans were unveiled on Monday. Spokespeople, including President Biden and Vice President Harris, laid out an “internet for all” plan in a public address.
The plan is to spend, on average, $750 million in each state in a bidding process for high-speed internet projects where there is none.
The overall thinking is that internet availability is viewed as a utility, much like the electrification of all communities.
President Biden indicated Made in America would be integral to the plan. Pointing out thousands of miles of fiber optic cable will be built and laid as part of the project.
Other investment areas that may see added demand is commodities such as copper. The metal is a key element in cables, routers, and switches. As a result, the demand for copper could be expected increase as more and more people connect to the internet.
Fiber optic cables were specifically mentioned in the announcement; manufacturers of not just the cable, but connections, and companies that install the cable could potentially benefit from the $42.5 billion being spread, for coast-to-coast high-speed internet.
While the project is to be completed over the next six years, for each new household or business that gains internet access along the way, a potential new customer for many types of businesses goes online. Beneficiaries could include telecommunications, media, education, online retail, and of course big tech. As the internet has more steady users, these industries will all see increased demand for their services.
Take Away
Investing in companies that benefit from changes in government policies or spending is a common strategy that has helped many portfolios.
A big announcement on what to expect from the new Bidenomics was made on June 26; the country is promised an even greater announcement on June 28. Investors should note, the government does not build out these projects themselves; it engages private companies. At times the US government quickly becomes a large customer of these companies’, adding stability of revenue and significant profit to bottom lines. The President promised a Made in America approach to the contract process.
The Importance Of Securities Research and Analysis May Inspire A Reversal in Regulations
The US Securities and Exchange Commission has avoided confrontation for a few years with European Union securities laws by extending exceptions to US brokers in the states that are subject to the EU’s MIFID II rules. The rules require that brokers charge clients separately for their analysis on stocks or bonds, and not provide it as an accommodation. In the US, charging for “advice” would cause brokers to have to register with FINRA as Investment Advisors – this opens up a new set of difficulties. The stand-off has been headed for a showdown for a while, and this coming July 3rd is when the SEC exception that exempts brokers expires.
Will Showdown be Averted?
The SEC exceptions to US brokers that have EU clients have been in place for five years, occasionally being extended – but the last extension expiring in a few weeks, may not get pushed out. SEC Chair Gary Gensler has been emphatic that he does not intend to extend any longer. The EU’s Markets in Financial Instruments directive threw a monkey wrench into a long-held custom of sell-side research by banning the common practice of accommodating clients by not directly charging for bond or equity analysis. Instead, in effect, “bundling” the service with research costs covered by trading commissions.
During the time that the EU has had MiFID II in place, an explicit price tag for research to investors has resulted in reduced company stock coverage. The new and growing concern is that the rules are hurting Europe’s financial markets — especially its small-caps. This is an important driver for the EU to consider a different tack.
Until now, without the SEC exemption from domestic rules, brokers in the huge US economy would have had to figure out how to take payment for research from their clients bound by MiFID. Or, alternatively, their clients would do without this important investment tool. The timeline is tight, but the problem for US brokers may be averted if the EU lawmakers act.
Will Europe Change Course?
With the SEC’s no-action letter expiring, the timing couldn’t be better. Investment firms following the rules of both regulators would cause a situation where US firms stop providing as much investment research to buy-side investors. Equity research is not only important to investors evaluating companies, but it is important to the companies themselves that need to be understood in order to attract capital and have enough active trading in their company to maintain suitable liquidity. This is especially true of small-cap and microcap stocks.
According to Reuters, the “states will seek a near total U-turn on the rules behind so-called unbundling.” MiFID II reforms, in place since 2018, may be adjusted to not conflict with the US model that separates brokers and investment advisors, requiring different licensing and different responsibilities of each.
The proposals suggest that an investment firm would only have to inform clients whether they are paying for research along with trading jointly, and record the charges attributable to each. This is different from unbundling, where from the client’s perspective, the research is a separate product, and decided on and paid for as an add-on to any other business.
Investors Could Win
While it was unclear how the showdown might come to an end, the new proposal, a dramatic turnaround from the EU on its current regulations, could finally resolve the regulator’s game of chicken and, at the same time, create an environment where investors benefit from more available information.
The original EU rule was intended to separate what lawmakers thought could be conflicts of interest when the selling broker also provides research while at the same time may have other banking and business relationships with the company it is providing research on.
The EU’s answer was to separate the two. But over time, according to Reuters, “evidence suggests research provision across the region has suffered as a result.” It lead to less research being distributed, which is viewed as negative to investors and the investor process.
What’s the Next Step?
The EU States’ plan talks with the European Parliament. The final shape of any regulatory changes will be decided in the negotiations, and the exact timetable for a conclusion is not yet clear.
Take Away
The prospect of a flip-flop on the MiFID rules comes at a key moment for the brokerage and securities research industries. In the US, a waiver allowing brokers to charge European clients separately for trading and for research is about to expire. At expiration, they’d have to adapt to the regulatory mismatch or drop the clients.
The drama is set against a very tight timeline.
As an interesting note, Channelchek is a platform that houses quality equity research and data on small and microcap companies. The information is at no cost to investors and is in no way tied to securities transactions. If you haven’t signed up to view this research, do this now.
Image: Securities and Exchange Commission, March 2019 (Flickr)
Is this the Most Aggressive SEC Ever? Former Commission Head Thinks So
Gary Gensler was nominated head of the Securities and Exchange Commission just after SEC Chairman Jay Clayton stepped down on December 23, 2020. Cryptocurrency exchanges welcomed the incoming Chair’s appointment as “Gensler unites a pro-regulation history with a pro-crypto viewpoint, and could finally implement the regulatory clarity many in the industry have desired,” said an opinion piece published in Coinbase two months after. It has now been two years, and Chair Gensler’s predecessor, in his new role, shared his views and criticisms this week.
Former SEC chairman Jay Clayton, who is now working in the private sector, said he believes government regulators could do a much better job serving investors and the broader financial markets. The comments came during an address (June 7) in Orlando as he spoke at the BNY Mellon Pershing Insite 23 Conference. In his talk, Clayton highlighted big differences between the SEC under the Biden administration in comparison to the Trump presidency.
“I think it’s pretty clear we’re in a very highly business-skeptical and commercial-skeptical regulatory environment,” he said. “Any time you go to extremes, either way, you get more bad than good.”
Clayton, is now the nonexecutive chair at Apollo Global Management, a large alternative asset manager. He held the position of SEC chairman from May 2017 through December 2020. He believes the regulatory whiplash leaves anyone participating in the financial markets with more questions than answers.
“People don’t know what is really happening, how long it is going to last, and what they should do about it,” he said in reference to what has been described as the most aggressive SEC ever.
Clayton acknowledged that his business is with an alternative investment house, and that he might be accused of “talking his book” as a representative of a firm that manages private investments, but explained that he believes retail class investors are being locked out of suitable investments. He believes there should be a democratization of alternative investments, which has been an SEC focus. The accredited investor policies may not be best for the average person planning for the future.
“Capital formation these days largely comes from outside the public markets, yet the investing public is largely held outside those private markets,” he said. “All investors should have access to a portfolio that looks like a well-managed pension fund. With the help of a lot of the people in this room, I think we’re going to be able to do it,” he optimistically said addressing the large group from the wealth management industry.
He called on investment management firms to do their part to help regulators by making an effort to create products that are more broadly suited to the full universe of investors. Clayton took particular issue with the current accreditation rules. Saying the 40-year-old accredited investor rule doesn’t jive with today’s reality, an environment where individual investors are largely responsible for their own retirement income.
The former SEC head pointed out what he thought to be absurd, mentioning qualified retirement accounts (401k, 403b, IRAs) that give retail investors access to highly liquid mutual funds and perhaps ETFs, but not less liquid investments that would be better suited for long-term investing objectives.
“You’re paying for liquidity that you don’t need and can’t access,” Clayton said. “Pick a target-date fund, for example, why wouldn’t there be a sliver of privates or alternatives in there? If I’m a 401(k) investor, I should be able to get something that looks like a Calpers portfolio. Why wouldn’t you have a 10% slice of privates in your retirement portfolio when you’re 50 years old?” He said referring to the large institution managing the California teachers retirement portfolio.
Take Away
The former SEC head Jay Clayton believes that the sharp move from lowering regulatoryinvestment hurdles, to erecting the most aggressive in history under the current leadership of Gary Gensler, is bad for investors. He doesn’t argue strongly for either side, as much as he is against sudden changes and the impact it has on investors.
Clayton also supports alternative funds for the average retail investor, especially as it relates to long-term savings such as retirement accounts.
Insite23, the investor conference Jay Clayton was addressing in Orlando, FL, draws wealth management professionals from across the US. This coming December, the Channelchek-sponsored investor conference, NobleCon19 will be held in Boca Raton, Fl. This annual conference, in its 19th year, draws institutional and self-directed investors from beyond the US, who wish to attend presentations, breakout sessions, and panel discussions with CEOs, and even former government leaders. Those attending this year’s NobleCon will get to assess lesser-known investment opportunities along with the current investment climate. Attendees can look forward to two days filled with actionable opportunities explained by those with direct knowledge at the company’s helm.
For information on attending Nobecon19, sponsoring, or presenting, click here.
Gary Gensler’s SEC Files 13 Charges Against Changpeng Zhao and His Company Binance
In a pair of press releases, one from the Securities and Exchange Commission, and the other from Binance, the world’s largest cryptocurrency exchange, there were charges, allegations and answers fired back and forth. The SEC named the founder and CEO of Binance, Changpeng Zhao as a defendant in the suit. Binance quickly shot back how disappointed Binance is that 13 complaints were filed against the company.
Allegations
The SEC press release indicates that they are suing Binance and founder Changpeng Zhao for misusing customers’ funds and for diverting funds to a trading entity that Zhao controlled called Sigma Chain. It further charges Sigma Chain for engaging in fraudulent trading that made Binance’s volume appear larger than it actually was.
Among the charges, Binance is also supposed to have concealed that it commingled billions of dollars in customer assets, sending them to a third-party, Merit Peak, which was owned by Zhao.
The SEC filed the case in federal court in the District of Columbia. Binance engaged in “blatant disregard of the federal securities laws and the investor and market protections these laws provide,” the regulator wrote in its court complaint.
Binance said in a written statement that it intends to defend its platform and denied allegations that user assets on the Binance.US platform were ever at risk. “All user assets on Binance and Binance affiliate platforms, including Binance.US, are safe and secure, and we will vigorously defend against any allegations to the contrary,” the company said. Binance.US also said it would defend itself against the litigation.
Binance alleges that because of their size, they are a target for the US regulator. The company expressed concerns through a press release that despite cooperating with the SEC, that a reasonable amount of time was not given on the most recent 26 different requests, and that they may have been intentionally burdensome. Binance said that despite its willingness to do whatever was necessary to address the US regulator’s concerns and take whatever reasonable steps they could, the SEC would not share any evidence it might have regarding its purported concerns, and the SEC rejected attempts at engagement, instead going straight to court. “It is now clear to us that the SEC’s goal here was never to protect investors, as the SEC has claimed—if that were indeed the case, the SEC would have thoughtfully engaged with us on the facts and in our efforts to demonstrate the safety and security of the Binance,” according to a company statement.
Channelchek will continue to follow and report on major news impacting this case and others of interest to the investment world. Various sources indicate that there does not appear to be any type of a run by customers from Binance, there are some reports that it is business as usual. Register here to receive our daily emails.
How Can Congress Regulate AI? Erect Guardrails, Ensure Accountability and Address Monopolistic Power
OpenAI CEO Sam Altman urged lawmakers to consider regulating AI during his Senate testimony on May 16, 2023. That recommendation raises the question of what comes next for Congress. The solutions Altman proposed – creating an AI regulatory agency and requiring licensing for companies – are interesting. But what the other experts on the same panel suggested is at least as important: requiring transparency on training data and establishing clear frameworks for AI-related risks.
Another point left unsaid was that, given the economics of building large-scale AI models, the industry may be witnessing the emergence of a new type of tech monopoly.
This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of Anjana Susarla, Professor of Information Systems, Michigan State University.
As a researcher who studies social media and artificial intelligence, I believe that Altman’s suggestions have highlighted important issues but don’t provide answers in and of themselves. Regulation would be helpful, but in what form? Licensing also makes sense, but for whom? And any effort to regulate the AI industry will need to account for the companies’ economic power and political sway.
An Agency to Regulate AI?
Lawmakers and policymakers across the world have already begun to address some of the issues raised in Altman’s testimony. The European Union’s AI Act is based on a risk model that assigns AI applications to three categories of risk: unacceptable, high risk, and low or minimal risk. This categorization recognizes that tools for social scoring by governments and automated tools for hiring pose different risks than those from the use of AI in spam filters, for example.
The U.S. National Institute of Standards and Technology likewise has an AI risk management framework that was created with extensive input from multiple stakeholders, including the U.S. Chamber of Commerce and the Federation of American Scientists, as well as other business and professional associations, technology companies and think tanks.
Federal agencies such as the Equal Employment Opportunity Commission and the Federal Trade Commission have already issued guidelines on some of the risks inherent in AI. The Consumer Product Safety Commission and other agencies have a role to play as well.
Rather than create a new agency that runs the risk of becoming compromised by the technology industry it’s meant to regulate, Congress can support private and public adoption of the NIST risk management framework and pass bills such as the Algorithmic Accountability Act. That would have the effect of imposing accountability, much as the Sarbanes-Oxley Act and other regulations transformed reporting requirements for companies. Congress can also adopt comprehensive laws around data privacy.
Regulating AI should involve collaboration among academia, industry, policy experts and international agencies. Experts have likened this approach to international organizations such as the European Organization for Nuclear Research, known as CERN, and the Intergovernmental Panel on Climate Change. The internet has been managed by nongovernmental bodies involving nonprofits, civil society, industry and policymakers, such as the Internet Corporation for Assigned Names and Numbers and the World Telecommunication Standardization Assembly. Those examples provide models for industry and policymakers today.
Licensing Auditors, Not Companies
Though OpenAI’s Altman suggested that companies could be licensed to release artificial intelligence technologies to the public, he clarified that he was referring to artificial general intelligence, meaning potential future AI systems with humanlike intelligence that could pose a threat to humanity. That would be akin to companies being licensed to handle other potentially dangerous technologies, like nuclear power. But licensing could have a role to play well before such a futuristic scenario comes to pass.
Algorithmic auditing would require credentialing, standards of practice and extensive training. Requiring accountability is not just a matter of licensing individuals but also requires companywide standards and practices.
Experts on AI fairness contend that issues of bias and fairness in AI cannot be addressed by technical methods alone but require more comprehensive risk mitigation practices such as adopting institutional review boards for AI. Institutional review boards in the medical field help uphold individual rights, for example.
Academic bodies and professional societies have likewise adopted standards for responsible use of AI, whether it is authorship standards for AI-generated text or standards for patient-mediated data sharing in medicine.
Strengthening existing statutes on consumer safety, privacy and protection while introducing norms of algorithmic accountability would help demystify complex AI systems. It’s also important to recognize that greater data accountability and transparency may impose new restrictions on organizations.
Scholars of data privacy and AI ethics have called for “technological due process” and frameworks to recognize harms of predictive processes. The widespread use of AI-enabled decision-making in such fields as employment, insurance and health care calls for licensing and audit requirements to ensure procedural fairness and privacy safeguards.
Requiring such accountability provisions, though, demands a robust debate among AI developers, policymakers and those who are affected by broad deployment of AI. In the absence of strong algorithmic accountability practices, the danger is narrow audits that promote the appearance of compliance.
AI Monopolies?
What was also missing in Altman’s testimony is the extent of investment required to train large-scale AI models, whether it is GPT-4, which is one of the foundations of ChatGPT, or text-to-image generator Stable Diffusion. Only a handful of companies, such as Google, Meta, Amazon and Microsoft, are responsible for developing the world’s largest language models.
Given the lack of transparency in the training data used by these companies, AI ethics experts Timnit Gebru, Emily Bender and others have warned that large-scale adoption of such technologies without corresponding oversight risks amplifying machine bias at a societal scale.
It is also important to acknowledge that the training data for tools such as ChatGPT includes the intellectual labor of a host of people such as Wikipedia contributors, bloggers and authors of digitized books. The economic benefits from these tools, however, accrue only to the technology corporations.
Proving technology firms’ monopoly power can be difficult, as the Department of Justice’s antitrust case against Microsoft demonstrated. I believe that the most feasible regulatory options for Congress to address potential algorithmic harms from AI may be to strengthen disclosure requirements for AI firms and users of AI alike, to urge comprehensive adoption of AI risk assessment frameworks, and to require processes that safeguard individual data rights and privacy.
ChatGPT-Powered Wall Street: The Benefits and Perils of Using Artificial Intelligence to Trade Stocks and Other Financial Instruments
Artificial Intelligence-powered tools, such as ChatGPT, have the potential to revolutionize the efficiency, effectiveness and speed of the work humans do.
And this is true in financial markets as much as in sectors like health care, manufacturing and pretty much every other aspect of our lives.
I’ve been researching financial markets and algorithmic trading for 14 years. While AI offers lots of benefits, the growing use of these technologies in financial markets also points to potential perils. A look at Wall Street’s past efforts to speed up trading by embracing computers and AI offers important lessons on the implications of using them for decision-making.
This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of,Pawan Jain, Assistant Professor of Finance, West Virginia University.
Program Trading Fuels Black Monday
In the early 1980s, fueled by advancements in technology and financial innovations such as derivatives, institutional investors began using computer programs to execute trades based on predefined rules and algorithms. This helped them complete large trades quickly and efficiently.
Back then, these algorithms were relatively simple and were primarily used for so-called index arbitrage, which involves trying to profit from discrepancies between the price of a stock index – like the S&P 500 – and that of the stocks it’s composed of.
As technology advanced and more data became available, this kind of program trading became increasingly sophisticated, with algorithms able to analyze complex market data and execute trades based on a wide range of factors. These program traders continued to grow in number on the largely unregulated trading freeways – on which over a trillion dollars worth of assets change hands every day – causing market volatility to increase dramatically.
Eventually this resulted in the massive stock market crash in 1987 known as Black Monday. The Dow Jones Industrial Average suffered what was at the time the biggest percentage drop in its history, and the pain spread throughout the globe.
In response, regulatory authorities implemented a number of measures to restrict the use of program trading, including circuit breakers that halt trading when there are significant market swings and other limits. But despite these measures, program trading continued to grow in popularity in the years following the crash.
HFT: Program Trading on Steroids
Fast forward 15 years, to 2002, when the New York Stock Exchange introduced a fully automated trading system. As a result, program traders gave way to more sophisticated automations with much more advanced technology: High-frequency trading.
HFT uses computer programs to analyze market data and execute trades at extremely high speeds. Unlike program traders that bought and sold baskets of securities over time to take advantage of an arbitrage opportunity – a difference in price of similar securities that can be exploited for profit – high-frequency traders use powerful computers and high-speed networks to analyze market data and execute trades at lightning-fast speeds. High-frequency traders can conduct trades in approximately one 64-millionth of a second, compared with the several seconds it took traders in the 1980s.
These trades are typically very short term in nature and may involve buying and selling the same security multiple times in a matter of nanoseconds. AI algorithms analyze large amounts of data in real time and identify patterns and trends that are not immediately apparent to human traders. This helps traders make better decisions and execute trades at a faster pace than would be possible manually.
Another important application of AI in HFT is natural language processing, which involves analyzing and interpreting human language data such as news articles and social media posts. By analyzing this data, traders can gain valuable insights into market sentiment and adjust their trading strategies accordingly.
Benefits of AI Trading
These AI-based, high-frequency traders operate very differently than people do.
The human brain is slow, inaccurate and forgetful. It is incapable of quick, high-precision, floating-point arithmetic needed for analyzing huge volumes of data for identifying trade signals. Computers are millions of times faster, with essentially infallible memory, perfect attention and limitless capability for analyzing large volumes of data in split milliseconds.
And, so, just like most technologies, HFT provides several benefits to stock markets.
These traders typically buy and sell assets at prices very close to the market price, which means they don’t charge investors high fees. This helps ensure that there are always buyers and sellers in the market, which in turn helps to stabilize prices and reduce the potential for sudden price swings.
High-frequency trading can also help to reduce the impact of market inefficiencies by quickly identifying and exploiting mispricing in the market. For example, HFT algorithms can detect when a particular stock is undervalued or overvalued and execute trades to take advantage of these discrepancies. By doing so, this kind of trading can help to correct market inefficiencies and ensure that assets are priced more accurately.
Stock exchanges used to be packed with traders buying and selling securities, as in this scene from 1983. Today’s trading floors are increasingly empty as AI-powered computers handle more and more of the work.
The Downsides
But speed and efficiency can also cause harm.
HFT algorithms can react so quickly to news events and other market signals that they can cause sudden spikes or drops in asset prices.
Additionally, HFT financial firms are able to use their speed and technology to gain an unfair advantage over other traders, further distorting market signals. The volatility created by these extremely sophisticated AI-powered trading beasts led to the so-called flash crash in May 2010, when stocks plunged and then recovered in a matter of minutes – erasing and then restoring about $1 trillion in market value.
Since then, volatile markets have become the new normal. In 2016 research, two co-authors and I found that volatility – a measure of how rapidly and unpredictably prices move up and down – increased significantly after the introduction of HFT.
The speed and efficiency with which high-frequency traders analyze the data mean that even a small change in market conditions can trigger a large number of trades, leading to sudden price swings and increased volatility.
In addition, research I published with several other colleagues in 2021 shows that most high-frequency traders use similar algorithms, which increases the risk of market failure. That’s because as the number of these traders increases in the marketplace, the similarity in these algorithms can lead to similar trading decisions.
This means that all of the high-frequency traders might trade on the same side of the market if their algorithms release similar trading signals. That is, they all might try to sell in case of negative news or buy in case of positive news. If there is no one to take the other side of the trade, markets can fail.
Enter ChatGPT
That brings us to a new world of ChatGPT-powered trading algorithms and similar programs. They could take the problem of too many traders on the same side of a deal and make it even worse.
In general, humans, left to their own devices, will tend to make a diverse range of decisions. But if everyone’s deriving their decisions from a similar artificial intelligence, this can limit the diversity of opinion.
Consider an extreme, nonfinancial situation in which everyone depends on ChatGPT to decide on the best computer to buy. Consumers are already very prone to herding behavior, in which they tend to buy the same products and models. For example, reviews on Yelp, Amazon and so on motivate consumers to pick among a few top choices.
Since decisions made by the generative AI-powered chatbot are based on past training data, there would be a similarity in the decisions suggested by the chatbot. It is highly likely that ChatGPT would suggest the same brand and model to everyone. This might take herding to a whole new level and could lead to shortages in certain products and service as well as severe price spikes.
This becomes more problematic when the AI making the decisions is informed by biased and incorrect information. AI algorithms can reinforce existing biases when systems are trained on biased, old or limited data sets. And ChatGPT and similar tools have been criticized for making factual errors.
In addition, since market crashes are relatively rare, there isn’t much data on them. Since generative AIs depend on data training to learn, their lack of knowledge about them could make them more likely to happen.
For now, at least, it seems most banks won’t be allowing their employees to take advantage of ChatGPT and similar tools. Citigroup, Bank of America, Goldman Sachs and several other lenders have already banned their use on trading-room floors, citing privacy concerns.
But I strongly believe banks will eventually embrace generative AI, once they resolve concerns they have with it. The potential gains are too significant to pass up – and there’s a risk of being left behind by rivals.
War Rooms and Bailouts: How Banks and the Fed are Preparing for a US Default – and the Chaos Expected to Follow
When you are the CEO responsible for a bank and all the related depositors and investors, you don’t take an “it’ll never happen” approach to the possibility of a U.S. debt default. The odds are it won’t happen, but if it does, being unprepared would be devastating. Banks of all sizes are getting their doomsday plans in place, and other industries are as well, but big banks, on many fronts would be most directly impacted. The following is an informative article on how banks are preparing. It’s authored by John W. Diamond the Director of the Center for Public Finance at the Baker Institute, Rice University, and republished with permission from The Conversation. – Paul Hoffman, Managing Editor, Channelchek
Convening war rooms, planning speedy bailouts and raising house-on-fire alarm bells: Those are a few of the ways the biggest banks and financial regulators are preparing for a potential default on U.S. debt.
“You hope it doesn’t happen, but hope is not a strategy – so you prepare for it,” Brian Moynihan, CEO of Bank of America, the nation’s second-biggest lender, said in a television interview.
The doomsday planning is a reaction to a lack of progress in talks between President Joe Biden and House Republicans over raising the US$31.4 trillion debt ceiling – another round of negotiations took place on May 16, 2023. Without an increase in the debt limit, the U.S. can’t borrow more money to cover its bills – all of which have already been agreed to by Congress – and in practical terms that means a default.
What happens if a default occurs is an open question, but economists – including me – generally expect financial chaos as access to credit dries up and borrowing costs rise quickly for companies and consumers. A severe and prolonged global economic recession would be all but guaranteed, and the reputation of the U.S. and the dollar as beacons of stability and safety would be further tarnished.
But how do you prepare for an event that many expect would trigger the worst global recession since the 1930s?
Preparing for Panic
Jamie Dimon, who runs JPMorgan Chase, the biggest U.S. bank, told Bloomberg he’s been convening a weekly war room to discuss a potential default and how the bank should respond. The meetings are likely to become more frequent as June 1 – the date on which the U.S. might run out of cash – nears.
Dimon described the wide range of economic and financial effects that the group must consider such as the impact on “contracts, collateral, clearing houses, clients” – basically every corner of the financial system – at home and abroad.
“I don’t think it’s going to happen — because it gets catastrophic, and the closer you get to it, you will have panic,” he said.
That’s when rational decision-making gives way to fear and irrationality. Markets overtaken by these emotions are chaotic and leave lasting economic scars.
Banks haven’t revealed many of the details of how they are responding, but we can glean some clues from how they’ve reacted to past crises, such as the financial crisis in 2008 or the debt ceiling showdowns of 2011 and 2013.
One important way banks can prepare is by reducing exposure to Treasury securities – some or all of which could be considered to be in default once the U.S. exhausts its ability to pay all of its bill. All U.S. debts are referred to as Treasury bills or bonds.
The value of Treasurys is likely to plunge in the case of a default, which could weaken bank balance sheets even more. The recent bank crisis, in fact, was prompted primarily by a drop in the market value of Treasurys due to the sharp rise in interest rates over the past year. And a default would only make that problem worse, with close to 190 banks at risk of failure as of March 2023.
Another strategy banks can use to hedge their exposure to a sell-off in Treasurys is to buy credit default swaps, financial instruments that allow an investor to offset credit risk. Data suggests this is already happening, as the cost to protect U.S. government debt from default is higher than that of Brazil, Greece and Mexico, all of which have defaulted multiple times and have much lower credit ratings.
But buying credit default swaps at ever-higher prices limits a third key preventive measure for banks: keeping their cash balances as high as possible so they’re able and ready to deal with whatever happens in a default.
Keeping the Financial Plumbing Working
Financial industry groups and financial regulators have also gamed out a potential default with an eye toward keeping the financial system running as best they can.
The Securities Industry and Financial Markets Association, for example, has been updating its playbook to dictate how players in the Treasurys market will communicate in case of a default.
And the Federal Reserve, which is broadly responsible for ensuring financial stability, has been pondering a U.S. default for over a decade. One such instance came in 2013, when Republicans demanded the elimination of the Affordable Care Act in exchange for raising the debt ceiling. Ultimately, Republicans capitulated and raised the limit one day before the U.S. was expected to run out of cash.
One of the biggest concerns Fed officials had at the time, according to a meeting transcript recently made public, is that the U.S. Treasury would no longer be able to access financial markets to “roll over” maturing debt. While hitting the current ceiling prevents the U.S. from issuing new debt that exceeds $31.4 trillion, the government still has to roll existing debt into new debt as it comes due. On May 15, 2023, for example, the government issued just under $100 billion in notes and bonds to replace maturing debt and raise cash.
The risk is that there would be too few buyers at one of the government’s daily debt auctions – at which investors from around the world bid to buy Treasury bills and bonds. If that happens, the government would have to use its cash on hand to pay back investors who hold maturing debt.
That would further reduce the amount of cash available for Social Security payments, federal employees wages and countless other items the government spent over $6 trillion on in 2022. This would be nothing short of apocalyptic if the Fed could not save the day.
To mitigate that risk, the Fed said it could immediately step in as a buyer of last resort for Treasurys, quickly lower its lending rates and provide whatever funding is needed in an attempt to prevent financial contagion and collapse. The Fed is likely having the same conversations and preparing similar actions today.
A Self-Imposed Catastrophe
Ultimately, I hope that Congress does what it has done in every previous debt ceiling scare: raise the limit.
These contentious debates over lifting it have become too commonplace, even as lawmakers on both sides of the aisle express concerns about the growing federal debt and the need to rein in government spending. Even when these debates result in some bipartisan effort to rein in spending, as they did in 2011, history shows they fail, as energy analyst Autumn Engebretson and I recently explained in a review of that episode.
That’s why one of the most important ways banks are preparing for such an outcome is by speaking out about the serious damage not raising the ceiling is likely to inflict on not only their companies but everyone else, too. This increases the pressure on political leaders to reach a deal.
Going back to my original question, how do you prepare for such a self-imposed catastrophe? The answer is, no one should have to.
