By Harrison Heaton
Throughout Global and American history, financial/banking regulation have been a key component for market transparency between financial institutions and whom they conduct their business with. Financial regulation exists for the sole purpose of maintaining the integrity/success of financial institutions. This has been the case through financial history and is still the case with recent changes in financial prosperity and rapid evolution within the finance sector.
A more recent concept within financial regulations that is confirmed is the termination of LIBOR. LIBOR stands for London Interbank Offered Rate, and it has been the universally accepted benchmark for many adjustable rate mortgages, financial instruments, loans offered by the bank, etc. LIBOR has a predetermined termination date of 12/31/2021, and its use has been on the steady decline since the 2008 crash due to investigations into LIBOR manipulation by traders which resulted in multiple millions of dollars in fines. One key concept that needs to be understood is that LIBOR is based completely on “expert judgement”, meaning the bank estimates what they believe they will be charged if they try to borrow money from other financial institutions and take the average of it. With the termination of LIBOR, a new rate calculation system is taking over and has been becoming more and more involved since its creation in 2014 by the Alternative Recommended Rates Committee (ARRC) called SOFR which stands for Secured Overnight Finance Rate. This rate is calculated through real, non-hypothetical transactions of other banks, which ensures more accurate transaction costs that could be easily monitored by the public. SOFR’s use of treasuries is what essentially makes the new rate so secure in its backing and the overnight portion of it allows for overnight reflective analysis on market conditions compared to the 1 through 6 month, or 1 year LIBOR rate. This is all to ensure financial institutions do not manipulate it like they did with LIBOR. Another plus of the switch is that SOFR is again based on the overnight treasury repo market which makes it very liquid , due to the high volume of transactions that occur within it every single day. This calls for urgency, so the Federal Deposit Insurance Corporation (FDIC) and Office of Comptroller Currency are urgently pursuing the early abandonment of LIBOR so that financial institutions can be ready come the new year.
As you can see in the two graphics above, SOFR is much more volatile than the period of choice LIBOR comparison. This is for the sole reason that SOFR uses overnight market analysis and daily transactions to conduct the rate for the specified period. In the above example, we can see the average extended period of SOFR. This extended average of SOFR looks very similar to the LIBOR trend line, due to the fact that it does not use daily transactions. On the Y axis and the key within the bottom image shows the rate that each method produces, but how you get to that rate is what makes all the difference in the world. Activity-Based fluctuation is the name of the game for SOFR which counteracts manipulation and gives a more accurate reading and rate for the consumer.
Moving on to another recent contributor to financial regulation has to do with crypto reporting taxable profits to the Internal Revenue Services. Essentially, within the new $1 trillion dollar infrastructure bill, Biden along with Congress proposed the introduction of a rule that would require “Brokers” of these digit asset transactions to report their customers to the IRS. However, there are numerous issues with this. First, the crypto community is outraged and confused about the bill being to broaden their definition of “Broker”. This created mass confusion due to the term “Broker” being potentially associated with other terms like “miners”, “developers”, and “validators”. All of these terms could technically act as “Brokers” within the blockchain and are essential parts of the transaction. This leads into the second problem with this new bill. These so-called “Brokers” can't identify their users. Due to these initial issues, 3 senators put forth amendments to the bill clarifying and exempting key components of the blockchain like the terms mentioned before. Exempting miners and including validators from reporting profits. Just as these amendments were getting configured, the Senate passed the bill unamended, meaning all changes would have to be issued at a later date and that confusion is still included within the wording of the bill. On one half of the argument, any regulation on crypto assets is a bad idea and costs more money to regulate, hurting the investors and decentavizing trading of these assets. On the other half of the argument, people say all profits on these assets should be taxed just like stock profits are taxed with capital gains and that adding these regulations and more specifically including 1099-B tax forms to investors makes the process of reporting tax information in regards to crypto smoother.
Through this visual above, we can see what firms and financial executives in their respected companies think the biggest issue with blockchain adaptation or crypto asset investing is. On the left side we can see their responses along with the percentage of others that agree with the response. Noticeably, most of the barriers are regulatory related. This is important because even the most prestigious and creditable within their field and knowledge accept the fact that regulation on these assets is something that is much more complicated than what may appear on the surface and passing a bill with confusing and broad terms that place an umbrella over everyone in the chain is not confidently handled.
Summarizing, Regulation has been involved in financial institutions for a while and has benefits and potential inhibitors with them. Regulations always change as a result of the changing financial markets. Recent times have tested financial regulation to the limit with crypto/blockchain assets and recent evolving regulations such as SOFR has given financial institutions more accurate information and rates.
Work Cited
Amadeo, Kimberly. “Do Regulations Keep Your Money Safer?” The Balance, 30 Apr. 2021, www.thebalance.com/financial-regulations-3306234.
Johnston, Matthew. “A Brief History of U.s. Banking Regulation.” Investopedia, Investopedia, 30 July 2021, www.investopedia.com/articles/investing/011916/brief-history-us-banking-regulation.asp.
Muller-Heyndyk, Rachel. “Six Regulatory Changes to Look out for in 2021.” The Global Treasurer, 3 Dec. 2020, www.theglobaltreasurer.com/2020/12/03/six-regulatory-changes-to-look-out-for-in-2021/.
Intelligence, Insider. “How the Laws & Regulations Affecting Blockchain Technology and Cryptocurrencies, like Bitcoin, Can Impact Its Adoption.” Business Insider, Business Insider, 27 Jan. 2021, www.businessinsider.com/blockchain-cryptocurrency-regulations-us-global.
Advisors. “LIBOR Replaced By Sofr - so Far, so Good?” Derivative Logic, Advisors Https://Derivativelogic.com/Wp-Content/Uploads/Derivative-Logic-Logo-Hrz.svg, 23 Sept. 2019, derivativelogic.com/dl-report-category/libor-replaced-by-sofr-so-far-so-good.
“The Libor Transition, Part 2: Challenges Associated with Sofr.” Quantitative Consulting and Data Analytics, www.summitllc.us/blog/libor-transition-part-2-challenges-with-sofr.
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