Even the Financial Stability Oversight Council Understands the Importance of Asset-Level Disclosure

Bloomberg ran an article that confirms that regulators have a sense that the only way to determine if a financial institution is systemically important is to look at its asset-level exposures.  Naturally, since asset-level exposures change over time, so too does the list of systemically important firms.

As regular readers of this blog know, what is important is that the asset-level exposures for all financial institutions are disclosed to all market participants.  Not that regulators label a market participant systemically important.  With this disclosure, market participants can then properly price their exposure to other market participants based on the riskiness of that market participant.

The largest danger that the global economy faces is that the Financial Stability Oversight Council will conclude that they are the only market participants who should see the asset-level exposures.  This conclusion would deprive market participants of the information they need to properly price risk and to take steps to protect themselves from contagion triggered by the failure of a firm.

Hedge funds, broker-dealers and mortgage companies may face unprecedented demands for data on everything from risk exposure to trading partners as U.S. regulators seek to identify firms that pose a potential threat to the financial system, a confidential government report says. 

The staff of the Financial Stability Oversight Council identified dozens of “potential metrics” to decide which non- bank financial firms should be designated “systemically important” and subject to Federal Reserve supervision, according to an 80-page study obtained by Bloomberg News. 

... “The FSOC will be after a lot of information,” Amy Friend, managing director of Promontory Financial Group in Washington, said at a Feb. 25 seminar at the U.S. Chamber of Commerce. 

.... “Firms that are concentrated in particular assets or sources of funding and revenues are susceptible to shocks from those assets or sources,” the study said in its list of possible data requests. “Large exposure to particular counterparties increases the likelihood that shocks to those counterparties will affect a firm.” 

... Financial companies don’t have any incentive to disclose more information than they do now, said Thomas Cooley, an economics professor at New York University’s Stern School of Business. 

“Opacity has been the friend of Wall Street firms,” said Cooley, who studies issues related to financial stability. “At least they see it that way. They probably make more money when people don’t know exactly what they are doing.” 

Data can be used as a “starting point” that can be supplemented by a more detailed analysis of each financial firm, he said. 

The data collection and analysis may be more important than the designations, said John Douglas, a partner in the financial institutions group of Davis Polk & Wardwell LLP in Washington. 

“A gentle information-gathering process from large, interconnected institutions is more useful and valuable than trying to make some artificial determination at this point as to which ones are systemically important,” Douglas said. “Knowledge and information will be extremely valuable, not some list.” 

... Agencies, including the Securities and Exchange Commission, are also proposing to step up demands for information from firms such as hedge funds, which SEC Chairman Mary Schapiro in November said have been “out of sight and were unknown to financial regulators and the public.” 

... Data is “so critical to regulators to get an aggregate picture,” the CFTC’s chairman, Gary Gensler, said in a Feb. 17 banking committee hearing.