With apologies to Jerome Kern and Oscar Hammerstein, and in the afterglow of a relatively amiable final AB Rule, we are reminded this week that our business remains hogtied to a regulatory establishment that can’t seem to stop regulating.  When a member of the regulatory apparatchiki hears someone observe, “Well, if I don’t get out of bed, I’ll never be in a car accident,” he or she starts thinking, well, maybe…a nice little rule could do wonders…!

When I sat down to write this piece, the Liquidity Coverage Ratio Rule (LCR) had not come out and this was just a generic Cri de Coeur over the incessantly punishing pace of regulatory change.And then between the first and last draft, the LCR lumbers onto the stage.

Before I get to the LCR, which deserves considerable attention right now, let me just highlight a couple of other examples from just this past couple of weeks.

It was reported this week that two of the three Democrats on the Securities and Exchange Commission said that the SEC ought to amend, the ink’s not even dry yet, “Final” Reg AB – by reinserting the requirement from the last lead balloon draft, that banks provide all investors with a bespoke computer program which would allow the investors to independently model investment products. This astonishingly bad idea was inspired by the notion (which reportedly was foisted on the SEC by a number of software consultants who were talking their book) that investors ought to be given their over analytical computer program to model bond performance. It was entirely unworkable and would actually decrease the quality of information available to investors. The investor community itself said this didn’t work, but bad ideas apparently just do not stay dead. 

And then we see the admission from the Office of the Comptroller of the Currency that the new derivatives counterparty risk rules would require the banks to raise over half a trillion dollars (that’s with a “t”) of capital to backstop ongoing trades! Now, I am as big a fan of adequately capitalized institutions as the next guy, but shouldn’t we figure out, before we act, whether that level of additional capital might unduly burden the swap market which is the mother’s milk of the international financial markets? And then, it is reported that the SEC continues to pursue the fantasy that asset managers are systemically important somehow and need to be looked at like SIFIs.   

So, the table is now set to talk LCR. At least for me, these 400 pages of commentary, explanation and rulemaking came out of the blue. It had been off my screen. Oh yes, we all knew Basel III was coming, but somehow I didn’t attach the importance to this event that apparently I should have. 

Quick version for CMBS fans:

  • CMBS will not count as high quality liquid assets in the numerator (no shock here);
  • Covered institutions (those with $250 billion of assets or more) will have to hold high quality liquid assets against the greater of 100% of the maturing obligations of any non-consolidated SPV of which it is a sponsor, or 100% of the amount of cash that it may be required to infuse into the vehicle, in each case during a 30-day period. 

These are, of course, entities for which no “sponsor” has any contractual liability. It is also every CMBS deal done in America. 

My pants may be on fire over this, but then again, perhaps not. The commentary makes crystal clear that the Fed, OCC and FDIC mean this to require capital against non-contractual obligations of a sponsor (“…the structured transaction outflow amount also includes outflows beyond contractual commitments because a sponsor may provide support despite the absence of such a commitment.” (pg.164)) 

So what’s a sponsor? The Rule gives us a Justice Potter Stewart definition of sponsor: you know it when you see it. The commentary expressly states, “…the agencies intend (the Rule) to apply to all covered companies that would have…implicit obligations to support a structured transaction of an issuing entity that is not consolidated by the covered company during a period of liquidity stress.”  So what in heaven is an implicit obligation and how to tell if one exists?  Does one wink?  Secret handshake?  Moreover, this missive goes on to say, “…the agencies consider covered companies to be sponsors when they have significant control or influence over the structuring, organization, or operation of a structured transaction.” (pg. 165)  Then to lard uncertainty on top of uncertainty, the Rule defines maturity in a tautology which is no help at all and appears to ignore or conflate the fact that at least CMBS issuers don’t issue debt but issue certificates representing undivided interest in the assets of the related trust. 

That is all in the commentary. What about the actual Rule? The bare words of the Rule (as opposed to the Commentary) don’t really add much about any of these key interpretative issues. What is going on here?  That’s a really good question. Why kill the trees necessary to print a 400 page missive and be that obscure?Is opaqueness intended? Isn’t this the transparency administration? And by the way, this Rule goes into effect in January of this coming year. So we have to sort this out in real time. Will we get more guidance? Do we really want more?

And now back to the theme on which I began. Each of these regulatory events is troublesome by itself, but collectively, they are exponentially more problematic. We are suffering a level of continuing tinkering that would have been unthinkable even a few years ago. This government is a man with a hammer to which every problem, every risk, every perceived unfairness, is a nail. There is a solution for every problem, but not every problem deserves a solution and when solutions are captured in hundreds or thousands of pages of regulatory minutiae, the solution itself becomes a problem, and an important one. The system can only tolerate so much tinkering. Even rules that are not in and of themselves overwhelmingly dysfunctional, burden the efficient operation of our financial marketplace that needs to thrive for our economy to thrive. We need to hit pause. We need to stop tinkering, at least for a bit. We need to understand that perfect cannot be the enemy of good.And we need to spend more time thinking about how all this regulatory activity both individually and in the aggregate will impact the economy. 

Ok, I get that this is a cry in the wilderness and there’s not a snowball’s chance in hell that we are going to reset the regulatory process, but no matter how hopeless the cause, we need to keep raising these issues and continue to focus both our elected representatives and our government on the unintended yet odious impact of and the real costs embedded in unending regulatory change.