Senate Finance Hearing The Annual Report and Oversight of the Office of Financial Research

At yesterday’s Senate Banking Subcommittee on Economic Policy hearing entitled, “The Annual Report and Oversight of the Office of Financial Research,” lawmakers heard testimony and questioned Richard Berner, Director of the Office of Financial Research (OFR), about areas of concern for financial stability and the OFR’s recent study on asset managers.

Opening Statements 

In his opening remarks, Sen. Jeff Merkley (D-Ore.) stated that, since the financial crisis, a series of important reforms to the market have been put in place. However he said “undoubtedly” there is more to left to do and Congress “should not stop grappling” with the question “have we done enough?”

Merkley said the government must do a better job of identifying and addressing systemic risk, noting that the OFR was created for this purpose and seeks to find gaps in data, while providing independent and transparent assessments of risk.  He concluded that it is important for the OFR to “get it right” when looking at areas ranging from asset managers to repo financing.

Sen. Dean Heller (R-Nev.) reminded the Committee that the OFR does not receive government funding and said that it “lacks accountability” and has the authority to collect “unprecedented amounts of data.”  Heller expressed concern with the asset management study put forth by the OFR and noted allegations that the study’s conclusions are unsupported, due to a lack of adequate data, and that it takes a “one size fits all” approach.

Witness Testimony 

Richard Berner, in his testimony, stated that the 2013 Annual Report shows the OFR’s commitment to being transparent and accountable to Congress, the Financial Stability Oversight Council (FSOC), and the public.  He explained that the annual report contains information on a new prototype tool that will be used to monitor financial stability and said that the OFR plans to develop more forward looking monitors.

Berner also noted that the OFR has been working with the Federal Reserve Bank of New York to measure activity in the short term funding market and that they are working on improving data standards, including the legal entity identifier (LEI).  He said the LEI will benefit the industry by lowering reporting costs, while providing better data to regulators.  In these efforts, he added, the OFR is acting as a global leader and organizer to push for universal adoption of the LEI, so that it can be as useful as possible.

Question and Answer 

Merkley began the question and answer segment by asking Berner to identify the top three risks to financial stability that he sees currently in the markets.  Berner replied that, while he cannot predict a crisis, the top three vulnerabilities to the financial system are: 1) market expose to a sharp rise in interest rates or volatility, as portfolios are positioned for low interest rates; 2) issues surrounding short term wholesale funding, namely securities lending transactions, because they do not have the advantages of deposit insurance or a lender of last resort; and 3) shocks emanating from elsewhere in the global markets, as disruptions abroad can “spill back” to the U.S. economy.

Next, Heller asked Berner if he believed the OFR study on asset managers should be “solely relied on” to designate asset management firms as systemically important financial institutions (SIFIs). Berner said that the report was put out only to inform the FSOC and that it is “only one ingredient” in the Council’s deliberations.  He stressed that there is a “sharp distinction” in the work done by the OFR and the decisions of the FSOC itself.

Heller noted that the study looked at the activities of firms rather than the firms themselves. He said that some have proposed that the size of a firm alone should indicate them as a greater source of risk.  He then asked if it would be appropriate for the Securities and Exchange Commission (SEC) to look into whether certain activities “deserve tighter oversight” rather than “simply selecting larger asset managers” and subjecting them to heighted supervision.

Berner agreed that the analytical focus should be on the activities of firms, including intermediary and counterparty activities, but said he cannot predict what other regulators may do.

Heller then stated that significant data gaps affected the macro-prudential analysis of the study, asking Berner if it was responsible for the OFR to publish a conclusion without complete and appropriate data to back it up.

Berner replied that it was responsible to put out the information and noted that the study stated the results were “just estimates.”

When Heller asked if the OFR ever directly asked asset managers for data, Berner said they did not ask directly but the OFR did engage with the industry, including trade associations and ten asset managers, to discuss their business models and how they manage risks.

In response to a question from Heller on whether or not the OFR worked with the SEC on the study, Berner said yes. He added that the OFR engaged “almost from the start” with the SEC and continued “aggressively for more than a year,” as they are the primary regulator for the industry and have the expertise in this area.

Sen. Elizabeth Warren (D-Mass.) commended the OFR for providing the report and starting a “robust and healthy debate” on the role that asset managers play in the financial system.  She then asked if the OFR has been able to obtain all the data that it has needed from other financial regulators including the SEC, Office of the Comptroller of the Currency (OCC), Federal Reserve (Fed), and Federal Deposit Insurance Corporation (FDIC), noting that they are not required by the Dodd-Frank Act to share their data.

Berner said “so far, yes” and explained that engagement with other regulators and sharing of data “requires a lot of thought and care” because much of it is non-public and confidential.  He noted that the OFR is working on a variety of processes to make sure there are memorandums of understanding and agreements in place ensure the data is secure. He also said the OFR is working to make sure that the FSOC adopts proposals to promote better data sharing while keeping information confidential.

Warren then asked if the OFR has ever used its subpoena powers to obtain data from financial companies.  Berner said that the OFR has never asked a U.S. firm to turn over their data, but said there are still gaps to fill in the information they would like to have.  He said the OFR will work carefully to ask companies for exactly the type of data they need, while taking steps to ensure cyber security threats to this information do not destabilize the financial system.

Sen. David Vitter (R-La.) asked Berner to respond to critiques of the study from former Rep. Barney Frank (D-Mass.) and American Enterprise Institute fellow Peter Wallison and to claims that the study is a prelude to SIFI designations. 

Berner reiterated that the study was not about specific firms and thus cannot be used as the basis for a SIFI designation.  He stated that his concerns lie in more opaque, separately managed accounts and stressed the need to “shine a spotlight” in this area.  Berner added that there could be destabilizing effects from abrupt market changes and collateral unwinding if asset managers invest cash received from securities lending in these accounts.

Vitter also noted there is industry frustration with the process by which the OFR conducts it research, calling it a “black box process.” He asked why the OFR is not more interactive in their discussions with stakeholders to give them a better sense of what they are thinking.

Berner replied that discussions with the industry were “vigorous” and that they have never turned down a request from the industry to have a meeting.  He added that the OFR continues to welcome engagement with asset managers and the opportunity to do more work in this area.

Sen. Pat Toomey (R-Penn.) shared Vitter’s concerns and said the report “in some ways may overstate risk” and that it minimizes the role of the “extensive regulation already in place” for asset managers.  He expressed concern with the impression the report creates and worried it may increase the chances of a SIFI designation for an asset management firm. He then asked Berner how additional prudential regulation through such a designation would diminish systemic risk.

Berner said that the OFR engaged extensively with the SEC to make sure they got the descriptions and effects of the current industry regulations correct.  He noted that he was not concerned with the accounts that are regulated under the 1940 Act but rather is concerned about vulnerabilities from accounts that are not subject to this regulation, namely separately managed accounts.  He noted that ’40 Act account portfolio lending is restricted to one third of the account, while separate accounts are not subject to this restriction.

When Toomey asked what transmission mechanisms create systemic risk when looking at asset managers, Berner said that external shocks to the market could be transmitted or amplified through fire sales of manager’s assets.

Second Round – Question and Answer 

In a second round of questions, Merkley asked Berner to further explain interest rate risks and vulnerabilities in the economy.  Berner said it is “hard to calibrate” what the OFR means when they say “a sharp and abrupt” rise in interest rates but that the amount is in the ballpark of 100 basis points.  He said that such an increase could be destabilizing because investments are skewed towards fixed income securities and shifting portfolio allocations would spill into other parts of the financial markets.

Heller asked if the OFR intended for their asset management report be public as they were working on it and asked if the OFR is willing to commit that any further research in this area will be public.

Berner said the OFR was aware the report would be public when they were working on it and said they are committed to making their work as transparent and open as possible.  He said that for future work, it is up to the FSOC to determine if it will be made public but stated if it is appropriate to release data and information, they will “find a way to do that.”

In closing comments, Berner said that more data is needed on the over-the-counter or bilateral parts of the repo markets and that he would like to investigate willingness to provide financing as well as the terms and conditions of financing in repo markets.

For more information on this hearing and to view a webcast, please click here