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[Senate Hearing 113-393]
[From the U.S. Government Publishing Office]

 
                                                        S. Hrg. 113-393

  THE ANNUAL REPORT AND OVERSIGHT OF THE OFFICE OF FINANCIAL RESEARCH

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                            ECONOMIC POLICY

                                 OF THE

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                                   ON

REVIEWING THE OFFICE OF FINANCIAL RESEARCH'S ANNUAL REPORT, DISCUSSING 
 OFR'S EFFORTS, ACTIVITIES, OBJECTIVES, AND PLANS, AND CONTINUING ITS 
 OVERSIGHT OF THE IMPLEMENTATION OF THE DODD-FRANK WALL STREET REFORM 
                      AND CONSUMER PROTECTION ACT

                               __________

                            JANUARY 29, 2014

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs

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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                       Taylor Reed, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

                    Subcommittee on Economic Policy

                     JEFF MERKLEY, Oregon, Chairman

             DEAN HELLER, Nevada, Ranking Republican Member

JOHN TESTER, Montana                 TOM COBURN, Oklahoma
MARK R. WARNER, Virginia             DAVID VITTER, Louisiana
KAY HAGAN, North Carolina            MIKE JOHANNS, Nebraska
JOE MANCHIN III, West Virginia       MIKE CRAPO, Idaho
HEIDI HEITKAMP, North Dakota

               Andrew Green, Subcommittee Staff Director

        Scott Riplinger, Republican Subcommittee Staff Director

                                  (ii)

                            C O N T E N T S

                              ----------                              

                      WEDNESDAY, JANUARY 29, 2014

                                                                   Page

Opening statement of Chairman Merkley............................     1

Opening statements, comments, or prepared statements of:
    Senator Heller...............................................     2

                               WITNESSES

Richard Berner, Director, Office of Financial Research, 
  Department of the Treasury.....................................     3
    Prepared statement...........................................    17
    Responses to written questions of:
        Senator Brown............................................    23

                                 (iii)

  THE ANNUAL REPORT AND OVERSIGHT OF THE OFFICE OF FINANCIAL RESEARCH

                              ----------                              

                      WEDNESDAY, JANUARY 29, 2014

                                       U.S. Senate,
                   Subcommittee on Economic Policy,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 3:30 p.m., in room 538, Dirksen 
Senate Office Building, Hon. Jeff Merkley, Chairman of the 
Subcommittee, presiding.

           OPENING STATEMENT OF CHAIRMAN JEFF MERKLEY

    Chairman Merkley. Good afternoon. I call this hearing to 
order of the Economic Policy Subcommittee of the Senate 
Committee on Banking, Housing, and Urban Affairs.
    I have a short opening statement. I believe that Senator 
Heller may be joining us in a moment. He may have a short 
statement, as well. And then we will turn directly to Dr. 
Berner's testimony. We are so pleased to have you with us 
today.
    Mr. Berner. Happy to be here.
    Chairman Merkley. A healthy, safe financial system is vital 
to a robust economy that works for middle-class America. From 
deposits to small business loans, retirement advice to loan 
insurance, to a home mortgage, to an auto loan for working 
families and the Main Street economy rely every day on the 
financial system to help them build a healthy financial 
foundation. This system is critical to a growing economy, as it 
also helps channel capital to new opportunities.
    But as we all remember from Jimmy Stewart and ``It's a 
Wonderful Life'', and more recently from our own experience in 
2008, the financial system can also be quite fragile. When 
firms have too little capital, too little oversight, or weak 
interconnections and volatile markets, in other words, when 
systemic risks go unaddressed, the result is often a banking 
crisis that can culminate in a great recession or a great 
depression. Ordinary families lose jobs, homes, savings, and 
businesses as lender and investor confidence dries up. There is 
no accident. It takes much longer to return to full employment 
after a financial crisis than after a simple recession.
    In the years since the 2008 crash, we have put in place a 
series of important reforms. We established a dedicated 
Consumer Protection Agency. We mandated clearing and 
transparent trading of derivatives. We separated hedge fund-
like betting from the loan-making banking system. We required 
higher capital in our banks. And we created the ability to wind 
down a failed financial company. Dodd-Frank has sought to 
restore protections and oversight to make our system work 
better for the middle class and to prevent future crises.
    Have we done enough? There is undoubtedly more to do and we 
should not stop grappling with that question.
    One clear lesson from the 2008 financial crisis was that 
neither the private sector nor the public regulatory agencies 
could adequately identify the risks they faced. In the future, 
we must do a much better job of identifying and addressing the 
systemic risks before it is too late.
    That is why Dodd-Frank created the Office of Financial 
Research. As its Congressional authors envisioned it, OFR is 
supposed to be a kind of National Institute of Finance, to cure 
gaps in data and analysis, to engage in and support cutting-
edge research, and to look through the complexity of our 
financial system and provide Congress and the public with 
independent and transparent assessment of what risks we face 
and what can be done about it.
    The mission set out for OFR is no small task, and it is 
important that OFR and others get it right, from understanding 
asset managers to monitoring repo and more. The Annual Report 
that we will hear about today is only the beginning of OFR's 
efforts to live up to that mission.
    This is the first appearance of Dr. Berner, or any OFR 
Director, before the Senate Banking Committee. I thank Dr. 
Berner for being here today and to further discuss OFR's work 
over the last year and the contents of its Second Annual 
Report. It is tremendous to have you, and we will now turn to 
Senator Heller, if you have an opening statement.

                STATEMENT OF SENATOR DEAN HELLER

    Senator Heller. I do. Thank you, Mr. Chairman, and thanks 
for holding this hearing today, and thank you, also, to Dr. 
Berner for being here and giving our Subcommittee an overview.
    Created by Dodd-Frank, the OFR serves the Financial 
Stability Oversight Council with the stated goals of improving 
the quality, transparency, and accessibility of financial data 
and information. I think it is worth reminding everyone that 
this Government organization does not receive Congressional 
appropriations and lacks standard accountability to Members of 
Congress, and most importantly, to the American public. Much 
like the Consumer Financial Protection Bureau, the OFR has the 
authority to collect unprecedented amounts of data from 
businesses.
    While there are many concerns about this organization, I 
will focus most of my attention today on OFR's September report 
on asset management and financial stability. In this report, 
the OFR alleges that asset managers could pose risks to the 
broader financial system. Since the report was released, there 
have been serious allegations that OFR's conclusions were 
unsupported by inadequate data, used one-size-fits-all 
modeling, and neglected to consider current regulatory 
frameworks.
    While there are certainly individuals who would like to 
argue whether one company or another should be labeled as 
systemically important, I think everyone should agree that 
those decisions should be made after evidence-based facts have 
been found through comprehensive evaluations.
    After a few years, both Republicans and Democrats have 
expressed concerns with OFR's actions, and even the Government 
Accountability Office has questioned OFR's standards. It is my 
hope today that Dr. Berner will provide some clarity and 
transparency about OFR's recent work and decisions.
    So, again, Mr. Chairman, thank you and I look forward to 
hearing Dr. Berner's testimony.
    Chairman Merkley. Thank you very much for your opening 
statement. The record will remain open for 7 days for 
additional statements or for questions for the record.
    Would the Senator from Massachusetts like to make an 
opening statement?
    Senator Warren. No, Mr. Chairman. I am ready to get right 
to the testimony and the questions. Thank you.
    Chairman Merkley. Thank you.
    I would now like to introduce Dr. Richard Berner, our 
witness. Dr. Berner has served as the first Director of the 
Office of Financial Research since January of 2013. Prior to 
his confirmation as Director, he served as counselor to the 
Secretary of the Treasury with responsibility for standing up 
the OFR.
    Before joining the Treasury in April 2011, he was cohead of 
Global Economics at Morgan Stanley. Dr. Berner previously 
served as Chief Economist at Mellon Bank, and before that, he 
worked as a Senior Economist at Morgan Stanley, Salomon 
Brothers, Morgan Guaranteed Trust Company. For 7 years, he 
worked on the research staff of the Federal Reserve Board in 
Washington. He has also been an Adjunct Professor of Economics 
at Carnegie Mellon University and George Washington University.
    More follows. Dr. Berner has been a member of the Economic 
Advisory Panel of the Federal Reserve Bank of New York, the 
Panel of Economic Advisors of the Congressional Budget Office, 
the Executive Committee and the Board of Directors of the 
National Bureau of Economic Research, and Advisory Committee of 
the Bureau of Economic Analysis.
    Dr. Berner has won forecasting awards from Blue Chip 
Economic Indicators, the Wall Street Journal, Market News, and 
the National Association for Business Economics. He received 
his Bachelor's degree from Harvard College and his Ph.D. from 
the University of Pennsylvania.
    Dr. Berner, welcome, and please begin.

  STATEMENT OF RICHARD BERNER, DIRECTOR, OFFICE OF FINANCIAL 
              RESEARCH, DEPARTMENT OF THE TREASURY

    Mr. Berner. Chairman Merkley, Ranking Member Heller, and 
Members of the Subcommittee, thank you very much for your kind 
introduction and the opportunity to testify today about our 
2013 Annual Report and oversight of the Office.
    Chairman Merkley, as you noted, this is my first Senate 
hearing as OFR Director, so let me take this opportunity to 
state my commitment to make the OFR a valued resource for the 
Congress, the Financial Stability Oversight Council, and the 
American people. This report and my testimony are two of many 
ways that we can inform the Congress and other stakeholders 
about our work. We are committed to being transparent and 
accountable, so I look forward to further opportunities to 
discuss with you our efforts to help promote financial 
stability.
    My written testimony covers in detail the topics in your 
invitation letter, so I just want to highlight a few of those 
topics now.
    First, our report documents how we are doing our job. We 
focus on potential threats to financial stability and the tools 
and data we are developing to assess and monitor them. In the 
report, we unveil a new tool, our Financial Stability Monitor, 
to identify and monitor such threats. By tracking five areas of 
risk and spotting vulnerabilities across the financial system, 
we aim to pinpoint causes of instability rather than just 
symptoms. The monitor is a prototype. We are already working to 
improve it. For example, we plan to develop more forward-
looking indicators to help us see not only where we are, but 
also where we are going.
    In the report, we identify eight potential threats to 
financial stability. One of those threats, instability in 
emerging markets, has affected U.S. financial markets in the 
last 2 weeks. Recent sharp declines in some emerging markets, 
economies, currency and asset markets, spilled over quickly 
into U.S. markets for risky assets, such as stocks. In 
coordination with Council member agencies, we are monitoring 
these developments carefully.
    We are mandated to fill key gaps in financial data and to 
implement data standards. The report outlines several OFR 
projects to improve the scope and quality of financial data. 
For example, we are working with the Federal Reserve Bank of 
New York to improve and expand data to measure activity in 
short-term funding markets. Data standards are critical to 
improve financial data quality, and we devote a whole chapter 
in the report to them.
    One key example is the Legal Identity Identifier. LEIs are 
like bar codes for uniquely identifying entities involved in 
financial transactions. They benefit industry by helping to 
lower reporting costs. They benefit regulators with better data 
for policy decisions. And they benefit researchers with 
consistent data for analysis. The Office has provided global 
leadership for the LEI system. We lead the U.S. regulatory 
delegation, and our Chief Counsel serves as Chair of the LEI's 
Regulatory Oversight Committee. To be truly useful, the LEI and 
other data standards must be universally adopted, so I have 
called on regulators in the U.S. and globally to require use of 
the LEI through regulatory rulemaking.
    Another data standard that is important to establish is a 
single cradle to grave standard for mortgage data called the 
Universal Mortgage Identifier. Our Annual Report and our latest 
working paper describe this proposal in detail. This 
standardization effort is a good example of how we coordinate 
with other agencies. In addition, publishing the proposal in 
our working paper series and our Annual Report illustrates two 
of the several ways we make our analysis and studies available 
to the public.
    The work I have just described is a fraction of what we 
have done and we plan to tackle much more in 2014. We no longer 
talk about standing up the OFR as an institution. The OFR is 
not only standing on its own, but is making important 
contributions to help promote U.S. financial stability. 
Hearings like this one are vital forums for you and the 
American people to receive timely and accurate information 
about our work and our plans. I look forward to further 
engagement.
    Thank you again for the opportunity to appear today. I 
would be happy to respond to your questions.
    Chairman Merkley. Thank you very much, Doctor, and I think 
we will have 5 minutes on the clock for each Senator and I will 
begin the questioning with this observation.
    If this was 2007, we might be expecting you to put up a 
chart showing the dramatic replacement of prime mortgages with 
subprimes. You might be talking to us about collateralized debt 
obligations and CDO-squared. You might be commenting on the 
risks imposed by credit default swaps that posed as--apparently 
created an insurance--attempted to create an insurance for 
mortgage securities, and whether or not those were actually 
backed up in the form that an insurance product needed to be 
backed up. You might have identified, also, the challenge with 
the rating of credit securities or mortgage securities and the 
model in which folks essentially find out what their rating is 
before they choose who will do the rating. You might have 
mentioned a whole bunch of things that were central to the 
meltdown that occurred in 2008.
    As you sit here today, if you were kind of recreating in 
this moment the key factors that we should consider to prevent 
a meltdown in 2016, 2 years from now, what would be the top 
three factors you would identify?
    Mr. Berner. Well, Senator, that is a great question, not an 
easy one to answer. Let me state first that when we think about 
the financial system, it is very hard to predict financial 
crises. In fact, I am not sure that we really can predict 
crises. We can identify, however, vulnerabilities, and it is 
those key vulnerabilities that we look to to see where the weak 
points are in the financial system that might be exposed by 
shocks to the system.
    So, as I think about the top three vulnerabilities that are 
out there right now, we have identified some of them in our 
annual report. One relates to the potential for the markets to 
be exposed to an abrupt and sharp rise in interest rates or in 
volatility. That is because while interest rates have risen 
somewhat, portfolios are still oriented toward the notion that 
interest rates would stay quite low, so a rise in rates could 
be disruptive. A rise in volatility in financial markets, 
likewise, could be disruptive, because that would change asset 
prices and have a profound impact on markets. So, those two 
related factors would be the first vulnerability that I would 
look to.
    The second vulnerability that I think has been mentioned 
many times before by others are the continuing issues 
surrounding short-term wholesale funding and securities 
financing transactions. Those are markets that are extremely 
important for the functioning of our financial system. They are 
markets that do not have the advantage that bank deposits have. 
They do not have a backstop from the lender of last resort. 
Deposit insurance does not cover them. And there are lots of 
proposals out there to make those markets stronger and more 
stable, although we have not yet implemented them and there is 
still risk in those markets and in related transactions.
    Chairman Merkley. You are referring to the repo markets?
    Mr. Berner. I am referring to repo markets, yes.
    Chairman Merkley. Repo, yes.
    Mr. Berner. Repo, among others, and related activities such 
as what is called the reinvestment of cash collateral in 
securities lending transactions. So those are all--that is a 
group of problems that we might focus on.
    The last of the top three might be the one I referred to 
before, and that is we live in a global, interconnected world. 
Markets are global. Institutions are global. Shocks that 
emanate from abroad, vulnerabilities that exist abroad, can 
spill over back to our markets and our economy. I think we need 
to be aware of those. I think the emerging market situation 
today, while it does not seem to be, at the moment, one that 
could spill over in the ways that it perhaps has in the past, 
it is something that we need to monitor pretty carefully, and 
it is that monitoring and assessment of where the potential 
risks might lie that really animates our work.
    Chairman Merkley. In the 40 seconds I have left, I was 
surprised to see that you had the spillovers from emerging 
markets, but not spillovers from the European markets. Any 
quick insight on that?
    Mr. Berner. I do. That is still an issue. The European 
economy is still troubled by slow or no growth. Their banking 
system still has many problems that are widely known. So, you 
cannot rule out that there would be problems that emanate from 
that source, as well.
    Chairman Merkley. Thank you.
    Senator Heller.
    Senator Heller. Thank you.
    Doctor, thanks again for being here. Your asset management 
report states that it was conducted to better inform FSOC as to 
whether or how to consider asset management firms, their 
designation as SIFI institutions, systemically important 
financial institutions. Do you believe that the OFR study 
should be solely relied on as FSOCs move forward with 
considering asset managers as systemically important?
    Mr. Berner. Senator, the report was put out to inform the 
consideration of the Council and it is only one ingredient in 
the Council's deliberations. I obviously cannot speak for the 
Council. I am a member of the Council, but a nonvoting member, 
so I cannot speak for the Council or its other members. But I 
want to draw a sharp distinction between the work that we do in 
support of the Council and the Council itself. The Council will 
decide on what to do with assessing truly whether there are 
threats in the activities of asset managers and what, if any, 
remedies ought to be taken in response to those threats. And 
our report was designed to inform the Council and to provide 
them with information. The work of the Council is ongoing and 
we continue to support the Council with data and analysis in 
that regard.
    Senator Heller. Also, your asset management report, you 
mentioned that OFR was looking for activities rather than 
particular firms. Some argue that the size of the asset manager 
alone would not or should not indicate whether it was a source 
of greater risk. Would it then be appropriate that the SEC 
should be looking into whether certain activities deserve 
tighter oversight rather than simply selecting larger asset 
managers and putting them under heightened supervision through 
SIFI designation?
    Mr. Berner. Well, Senator, I definitely agree with the 
notion that the analytical focus that should be used in looking 
at asset management activities is the activity. That captures 
where the activity is being undertaken, whether it is in an 
asset manager or its counterparties, its clients, and its 
intermediaries. And so I think that is a better way to look at 
the potential problems. I cannot prescribe what other 
regulators should do, but I think that is the way to look at 
it.
    Senator Heller. Has there been a designation of a SIFI, any 
SIFI designations up to this point?
    Mr. Berner. Senator, there have been designations of a 
captive finance company and two insurance companies----
    Senator Heller. OK.
    Mr. Berner. ----and the process continues.
    Senator Heller. In that report, it also stated that 
significant data gaps impeded effective macroprudential 
analysis and oversight of asset management firms and 
activities. The question is, is it responsible as a researcher 
to publish any conclusions in a report without complete and 
appropriate data to back those conclusions?
    Mr. Berner. Well, Senator, I think it is responsible to put 
the information out there. We clearly indicated that our 
estimates of a variety of metrics relating to the asset 
management industry were just that, estimates. Because there 
are data gaps, we would like very much to focus on some of the 
areas for which we do not have adequate data and to fill those 
gaps so that we can do more work on looking at the industry. 
Those include separately managed accounts for which we have 
only scarce data, as well as more detailed data on securities 
lending transactions, which, as I mentioned earlier, could be 
the source of a potential problem.
    Senator Heller. Did you ever ask asset managers directly to 
provide data of their asset management report?
    Mr. Berner. We have not directly asked asset managers to 
provide any data. We did, however, engage with--vigorously with 
ten asset managers and the industry and trade groups 
continually to discuss their business model, their business 
mix, how they manage their risk, other factors relating to the 
very detailed nature of their business. So, we have had a lot 
of discussions with the industry itself.
    Senator Heller. Did OFR ever work with the SEC on this 
report before issuing a final product?
    Mr. Berner. Yes, we did. We engaged with the SEC almost 
from the start, because they are the primary regulator for most 
of these companies and they have the expertise, long acquired, 
to look at these companies. So, we wanted to make sure that we 
were on the same page, both with respect to the existing 
regulation, the nature of the businesses, and where the 
problems might arose. And so on all three accounts, we did 
engage aggressively for more than a year with the SEC and had, 
I cannot tell you how many phone calls, et cetera, meetings 
with them, to talk about this report.
    Senator Heller. Doctor, thank you. Mr. Chairman.
    Chairman Merkley. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman, Ranking Member, 
for holding this hearing. Thank you for being here, Dr. Berner.
    So, the OFR obviously plays a very important part in our 
regulatory system. In essence, your job is to look at the data 
and the gaps in the data and identify possible sources of risk 
in the financial system--no politics, just an independent 
analysis of what is going on. I think it is a really important 
role.
    And that is exactly what OFR did in its recent report on 
asset managers. You reviewed the available data, you identified 
serious gaps in the data, and you raised some issues that 
prompted a robust and healthy debate about the role that asset 
managers play in the financial system. So, I want to say, thank 
you, Dr. Berner, for the work you and your staff put into that 
report. I think that is very important.
    Mr. Berner. Thank you.
    Senator Warren. So, what I want to focus on, though, is the 
importance of collecting the necessary data, because you 
identify data gaps in this report. So, I imagine that the 
agencies that oversee the financial system, the SEC, the OCC, 
the Fed, the FDIC, have all sorts of data that the OFR would 
find helpful in its research, and yet as I read Dodd-Frank, 
those agencies are not required to share the data with OFR. So, 
what I want to ask about is whether OFR has been able to obtain 
all of the data it needs from these agencies.
    Mr. Berner. Thanks for your question. The answer to your 
question is, so far, yes, but I want to emphasize the fact that 
the engagement with our colleagues elsewhere on the Council is 
one that requires some thought and some care, and that is 
because many of the data sets that we look at that they collect 
are nonpublic data and they have confidential information in 
them.
    Senator Warren. I understand.
    Mr. Berner. As a consequence, they want to be assured that 
the data that they share with us are kept as secure as they 
would keep them, and so we have worked out a process to exactly 
do that, a variety of processes to make sure there is an 
agreement, a memorandum of understanding between us for each 
characteristic of each particular data set, and sometimes that 
takes time to work out. The more specific we can be in our 
request, the more finely we can tailor those agreements to 
reflect the nature of the data.
    We are working hard on data sharing, which is something 
that we think is necessary for the Council, not just for us, to 
do its job. We have made several proposals on how to make that 
easier. The Council of Inspectors General for Financial 
Oversight has made several proposals on that and we are working 
hard in the context of the Council to make sure that the 
Council embraces and adopts those proposals so that we can 
better share data, on one hand, while keeping them confidential 
on another.
    But, we have obtained data in several different areas and 
we are using those very detailed nonpublic data to analyze 
interconnectedness and risks and the transmission of risks 
across the financial system.
    Senator Warren. Well, good, because I think it is very 
important that all of the agencies be sharing data with you. I 
am glad you are working on the MOUs to make that possible. And 
I hope there are no difficulties in data sharing as we go 
forward, because without good data, you cannot give good 
independent advice. So, let us know if there are problems 
there.
    But, I want to ask you one other data question in this, and 
that is about your ability to obtain data from financial 
companies. I know that you have subpoena power to require 
companies to produce data under certain limited circumstances, 
but from what I understand, you have never used that power, is 
that right?
    Mr. Berner. That is true, and we actually have never asked 
a financial company in the United States to turn over data to 
us because there are many data that are available already, as 
you indicated, that are collected by other agencies, that are 
publicly available or available in some other form. And so our 
philosophy for filling data gaps has three steps. First is to 
prioritize and identify the questions we want to answer. 
Second, to take stock of the data we have, and we just 
published a very recent data inventory on our Web site to do 
exactly that. And then matching those two things enables us to 
sort of look to where the gaps in data are and to prioritize 
them.
    Now, there are still lots of gaps in data, as you and I 
agree, and what we need to do is to work very carefully to 
think about asking the companies for exactly what we need, to 
make sure, just as we do with other regulators, that those data 
would be kept secure if they are nonpublic data, and 
confidential, to assure the companies that their data will not 
be in jeopardy, their data will not be compromised, and that is 
particularly important in today's environment, where we are all 
concerned and trying to take steps to assure that threats, 
cybersecurity threats, do not destabilize our financial system.
    Senator Warren. Well, I very much appreciate that you are 
cautious in your data requests, both from other agencies and 
from financial institutions, but at the same time, I hope you 
are vigorously pursuing everything that you need and that you 
have all of the tools you need to get those data, because 
without good data, you will not be able to make good 
recommendations. I know you know that and I just want to offer 
my support for your ability to get the information that you 
need to help advise us all about the risks we face in the 
financial system. Thank you.
    Mr. Berner. Thank you, Senator. If I need any help, I will 
be sure to let you know.
    Senator Warren. Good.
    Chairman Merkley. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman, and thank you, Dr. 
Berner, for your work and for being here.
    Like several others, I have a concern about the possible 
push to designate several asset manager firms as systemically 
important, and I apologize if you all have discussed this 
before I came. And it is interesting, in this specific issue, 
in this case, you have some very divergent people and views in 
terms of financial services, like Barney Frank and Peter 
Wallison both agreeing that they do not think this should be 
considered. Barney Frank, in particular said, quote, ``it just 
seemed to me a listing of possible horror stories with no 
indications that there was any significant likelihood of any of 
it happening. Systemic risks occur not only when people lose 
money, but when the people who lose money cannot back up their 
losses and you get this cascading effect. That would make 
everyone in America a systemic risk. I was really disappointed 
in that one,'' close quote, talking about, I think, part of 
your study. Can you react to that in general and the Peter 
Wallison and Barney Frank critique of this possible movement in 
this direction?
    Mr. Berner. Senator, if I could, I would like to separate 
the identification of possible risks and asset management 
activities from any remedies that might be taken in response to 
those risks. Part of our job is to identify the risks and where 
they might lie and to provide the framework of analysis and the 
data, as we were just discussing, to identify those risks. The 
Council's job is to also work on identifying those risks, but 
also to propose and potentially implement any remedies. So, I 
am not in the business of proposing remedies. I am in the 
business of trying to identify where the risks might lie and--
--
    Senator Vitter. Well, first of all, I understand that, but 
obviously, the study is a prelude to that decision, so they are 
closely related. And, second, it seems to me this critique is 
about characterizing the nature of the risk.
    Mr. Berner. Well, the study focused on activities, not on 
firms, and the study, therefore, analytically could not be used 
as the sole basis for any designation process.
    Senator Vitter. Yes. I did not say it would be the sole 
basis.
    Mr. Berner. And, frankly, it could not be really used as 
the basis, because to designate a firm, you need to do the 
analysis that relates to that firm. We wanted to look at 
activities because we fully recognize that asset managers are 
basically in the business, and in the agency business, they 
manage assets on behalf of their clients, not on behalf of 
themselves. It is, as you indicated earlier, it is money that 
they--where the client may lose money, but the asset manager 
itself may not be threatened by a simple change in market 
value.
    Those are not the risks that we are concerned about. We are 
concerned about other risks that we talk about in the report in 
some of the activities in asset managers, where there is 
opacity, for example, in separately managed accounts, which we 
think are roughly 40 percent of assets under management by U.S. 
firms on a global basis. We need to shine a spotlight in those 
areas and find out more about what is going on in those 
accounts.
    Second, we pointed out that when asset managers lend out 
their securities in a securities lending transaction, they get 
in receipt for the lending of those securities, they get cash 
back that they can then reinvest. If there is an abrupt change 
in market prices, that investment of the cash collateral, as it 
is called, that comes back, could unwind quickly and could have 
destabilizing impacts on markets. So, asset managers are 
affected by market developments, and if they are sharp changes 
in market prices, or a sharp change in perceptions, then their 
activities could give rise to potential threats to financial 
stability, and we think those are some of the vulnerabilities 
that we need to take a closer look at.
    We have not arrived at any conclusions, as I said, about 
remedies. We are simply looking at potential threats.
    Senator Vitter. Related to this, let me also ask you about 
process. A lot of the firms involved and others, including 
members, have been frustrated and concerned about what they 
consider sort of a black box process and very little ability 
for folks in the business who know the details of their 
business to see elements of an ongoing study and react to it or 
critique it in a constructive way at all. I know there is not 
any legal requirement for you to have some sort of comment 
period, but what is the purpose of not being more interactive 
than you are in doing studies with the goal of getting the 
study right and understanding as good as possible what the true 
facts are and situations are in the real world?
    Mr. Berner. Senator, as I indicated earlier, we engaged 
with ten large asset managers in considering our study. We sent 
teams of experts to visit with those asset managers. I 
personally went to visit with five or six of them, or were on 
the phone with some of the others. I spent 30 years in the 
business, so I have a lot of contacts in the asset management 
industry with whom I consulted and we all consulted in putting 
the report together.
    I think that it is important to recognize that we have a 
transparent, open door policy. There is not a single asset 
manager, not a single trade group, representatives of asset 
managers, who asked to have a meeting with us that we have 
turned down. We repeatedly----
    Senator Vitter. I do not want to interrupt, but I think if 
you talk to them and ask them, they will say, yes, we had a 
meeting and we got no reaction from anyone about what the 
thinking was or where this might be headed and no real ability 
to react to that. And so that is what they thought was 
completely lacking.
    Mr. Berner. Senator, all I can say is that I found those 
meetings very constructive. There was a vigorous give and take 
at those meetings about--and a lot of questions about the 
things that we might be concerned about, some of which I 
mentioned earlier. So, I cannot speak for them. All I can do is 
say that those discussions were vigorous. We continue to 
welcome engagement with the industry. We continue to welcome 
opportunities to talk to the industry. And we continue to 
welcome the opportunity to do more work in this area.
    Senator Vitter. Well, I would just ask you to think about 
that process----
    Mr. Berner. OK.
    Senator Vitter. ----because there is real frustration about 
that process from their point of view, about hearing where 
might be headed or what your sort of draft thoughts are and 
having an opportunity to react to that rather than just be able 
to make a presentation to sort of a stone-faced representative, 
and I think that is an accurate description of most of their 
reaction. It took the SEC, for instance, to put the study out 
to comment in any way, so that certainly was not formally done 
by you all. But thank you.
    Chairman Merkley. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman, and I appreciate 
your indulgence in allowing me to attend, since I am not on the 
Subcommittee, but I am on the full Committee, and I appreciate 
your having this hearing.
    Dr. Berner, thank you very much for being here. I kind of 
want to go down a similar road that Senator Vitter went down, 
and I share his concern that I think you could argue that the 
September report in some ways may overstate the risks and in 
some ways minimizes the very extensive regulation that is 
already in place on asset managers. And our concern--some of us 
are concerned that if that is the impression that the report 
creates, it might increase the chances of a SIFI designation, 
which I think would be a big mistake, and I understand that is 
not your call, and I am not suggesting that that was your 
intent, but it could be the consequence.
    And so one of the things that strikes me is that the report 
does not spend much emphasis on the very extensive regulation 
that is already in place, has been in place on asset managers 
for a very long time. As you know, they are regulated by the 
SEC, the CFTC, the DOL, the Treasury Department, as well as 
international regulators. Senator Vitter pointed out quite 
rightly that even Congressman Barney Frank suggested that Dodd-
Frank was never intended to result in asset managers being 
designated as SIFIs.
    And so in light of the extensive, and, I would argue, very 
effective regulation that this industry has been subject to for 
a very long time and continues to be subject to, I guess, could 
you reflect on how additional either prudential regulation or a 
SIFI designation, how would that diminish systemic risk 
throughout the system?
    Mr. Berner. Senator, as I mentioned earlier and as you 
indicated, the actual remedies for any threats to financial 
stability are not in my bailiwick. But, I think the basic--I 
would like to make a couple of points.
    One is that when we engaged with the SEC, one of the 
reasons that we engage so extensively and over a long period of 
time with the SEC was to make sure that we got the description 
as well as the effect on the industry of the regulations that 
exist. And there are, as you well know, two basic parts to the 
industry. The '40 Act funds that are regulated extensively and 
comprehensively by the SEC are not our primary concern, 
although there are some issues potentially that might exist in 
the activities of asset managers that relate to those funds.
    It is in other areas and other activities that we see 
potential problems and potential vulnerabilities. And so that 
is why I keep emphasizing the basic fact that it is those 
activities that I think are important to focus on. It is those 
activities where we have to do more work, more analysis. It is 
those activities where--for which we lack adequate data right 
now to do the analysis and for which we intend to collect on an 
appropriate basis and in an appropriate way additional data so 
that we can do the work on those activities.
    Senator Toomey. So, systemic risk by its very nature is a 
risk that is transmittable throughout the system, throughout 
institutions. Otherwise, it is not systemic, right. Could you 
just give us some thoughts about what are the transmission 
mechanisms you are concerned about with respect to asset 
managers.
    Mr. Berner. Well, again, focusing on asset management 
activities, one of the things that concerns us is that if an 
asset manager is hit by an external shock, even if it is not 
the source of that shock, it could transmit or amplify to the 
rest of the financial system through its activities that shock.
    Senator Toomey. How would it transmit them?
    Mr. Berner. It would transmit them through potentially what 
are called fire sale, if the asset manager in question--a fire 
sale is a sale of assets at prices well below their indicative 
value----
    Senator Toomey. Right, but just to explore that a little 
bit, right----
    Mr. Berner. Mm-hmm.
    Senator Toomey. If there were a specific problem with a 
specific manager that caused the investors to decide they 
wanted to withdraw their money, is it not quite likely they 
would just put their money with a different manager, because 
they want to be invested in the markets under this scenario. 
They have just got a concern with this particular manager.
    Mr. Berner. Right. And that is why, Senator, I am talking 
about activities. So, if a lot of asset managers are doing 
similar things, and these problems affect more than one asset 
manager, they affect the activities of a particular asset 
manager rather than a specific firm, that is the circumstance 
where we think there might be potential threats. So, it is not 
about the firms as we characterize it and as we do our 
analysis. It is about the activities in which those firms 
engage, and those are the things that we need to keep in mind.
    Senator Toomey. And those activities are regulated now by 
the SEC and other--principally, but other regulators, as well, 
right?
    Mr. Berner. Well, the regulation of--they are all 
regulated, for example, by the Department of Labor, by ERISA, 
as Senator Merkley and Senator Heller indicated, but the 
regulation of, for example, activities in separately managed 
accounts is quite different from the regulation that oversees 
so-called '40 Act accounts.
    So, let me give you an example. In '40 Act accounts, there 
is a restriction on the extent to which you can lend out for 
securities lending purposes the portfolio that you are 
managing. It is limited to roughly a third. In separately 
managed accounts, however, there is no such limitation. You can 
lend out the entire portfolio.
    So, a firm that engages in securities lending activity may 
choose to lend out the entire portfolio from its separately 
managed accounts, but that is something that we are not quite 
sure of, where there is a lot of opacity around, and if you are 
lending out the whole portfolio and the circumstances arise 
that would create the unwind that I was talking about, then 
that is something that we should know more about. It is 
something that we should try to monitor and to try to assess 
where the risks are.
    Senator Toomey. Thanks very much. Thank you, Mr. Chairman.
    Chairman Merkley. Thank you very much, and I think folks 
are interested in another round of questions.
    I wanted to start with the two issues that you identified 
as number one and number two, a potential sharp rise in 
interest rates and then the repo markets and the potential 
contagion effect that can occur between firms. In regard to a 
potential sharp rise in interest rates, of course, up here on 
Capitol Hill, we hear the words ``sharp rise in interest 
rates'' and we are thinking in the context of U.S. Treasury 
bonds and what that means to our budget. But that may not be 
exactly what you are concerned about here, so paint out a 
couple scenarios that lead to the sharp rise in interest rates 
and where those interest rate rises occur, and then how those 
reverberate through the economy in ways we should be concerned 
about.
    Mr. Berner. Well, Senator, it is a good question. The rise 
in rates that could be destabilizing, it is hard to calibrate 
exactly what we mean by sharp, or hard to characterize what we 
mean by abrupt. But right now, the fact is that we live in a 
relatively moderate growth, low inflation environment and 
investors have embraced that and they positioned their 
portfolios to take account of that.
    So, portfolios are skewed toward fixed-income securities 
and they are skewed toward the longer end of the yield curve, 
longer-term securities, and we have seen a rise in interest 
rates there. The rise that occurred last, I think, last spring 
and summer is a possible foretaste of what could happen if 
rates were to rise more sharply.
    One of the things that is very difficult to do is to 
predict when the rise might occur, how sharp it would be, and 
exactly what its sources might be. Our job is to try to 
identify what the impact of such a rise in rates might be. We 
can conduct, or construct scenarios that might entail such a 
rise in rates. Ten-year Treasuries, for example, are around 
two-and-three-quarters percent. Other rates are aligned with 
them. If they were to rise sharply, by 100 basis points or 
more, that is in the ballpark of what we are talking about for 
a sharp rise in rates.
    That would create a shift in portfolio allocations. It 
would create a shift in market expectations. It would spill 
over into other parts of the financial markets as we saw last 
summer.
    Chairman Merkley. So, I think many folks might consider the 
current low rates to be the anomaly and that a higher rate 
might be more expected over time. But, my question, what is the 
source of that higher rate? For example, if this is a change in 
monetary policy that drives this, that is one factor. If it is 
a loss of confidence in the ability of the U.S. Government to 
pay its debts, that is entirely something different. Can you 
spin out a couple scenarios that you have particular concern 
about?
    Mr. Berner. The Fed has been very careful about the way it 
is conducting its monetary policy, and we have seen that the 
Fed, even today, announced another adjustment in its monetary 
policy, and the way they are doing that has not had a big 
impact on interest rates. But, if circumstances change, then 
the Fed may have to change, as well, and predicting when 
circumstances might change is difficult. If we, ironically, if 
we have faster growth, then rates could rise significantly. The 
faster growth would be a great thing, more jobs, more growth, 
more housing, more consumer spending.
    If, on the other hand, rates rose because investors were 
concerned about our creditworthiness, as you point out, that's 
a different source. That would not be productive. And, in fact, 
one of the risks we identify in our report is the lingering 
uncertainty over our--the progress we are making or not on 
dealing with our long-term fiscal problems. So, those are 
factors that we consider in thinking about what the source of 
an interest rate rise might be.
    Chairman Merkley. Well, thank you.
    Senator Heller.
    Senator Heller. Thanks again, Mr. Chairman.
    Doctor, I want to go back to what Senator Toomey was 
talking a little bit about. You have done a good job, in my 
opinion, to identify some of the concerns, repos, derivatives, 
other exchange-traded funds that you look at in your concern 
for certain activities. I guess my question, and going back to 
what Pat said, was that you are an asset manager and, 
basically, you have an agreement, an investment agreement, with 
your client. What keeps that client from going from one asset 
manager to another if they are recorded or designated a SIFI, 
or perhaps even participating in this activity on their own?
    Mr. Berner. Senator, nothing--it is true that if you do not 
like the business you are conducting with one firm, you can 
move your investments to another firm. But that is not really 
what we are talking about. What we are talking about is 
activities that are widespread across the asset management 
industry that are engaged in by a number of firms, identified a 
couple. If those activities were not very important and not 
widespread, then, obviously, they would not be that important 
for assessing risk to the entire financial system. But, because 
they are widespread and because they are important and because 
they do contain the potential for risk when stress arises in 
the financial system, that is why I think we want to focus on 
them in thinking about where the vulnerabilities to our system 
might lie.
    Senator Heller. OK. While you were working on your report, 
was it your intent to make it public or a private report?
    Mr. Berner. While we were working on the report, we thought 
hard about the fact that we are committed to being transparent 
and open and want to engage with the public and want to engage 
to get comments on our work, and we certainly had no shortage 
of those. We are always committed to making our work available 
and public in many ways and many forms, and we want to be as 
transparent as possible, so--and that is true when we engage in 
meetings with asset managers in other firms. It is true when we 
engage with the public in general. We want to make sure that we 
are as open and disclosing as possible.
    Senator Heller. So, if I understand correctly, are you 
willing to commit that any future OFR research on this topic 
will be made public, and also any future agency meetings, you 
will disclose?
    Mr. Berner. Well, Senator, if the Council asks us to do 
work and it is work that we do on behalf of the Council, then, 
you know--and it is the Council's property, then the Council 
would have to make some of those decisions. We exist to serve 
the needs of the Financial Stability Oversight Council, and if 
that work is, in their judgment, something that is a draft or 
predecisional or in other ways not appropriate because it might 
contain confidential data, for example, for public 
distribution, then the Council would have the final say. 
However, I just want to make sure that you understand that if 
it is appropriate to release information, if it is appropriate 
to release our analysis, if it is appropriate to release data 
that we have collected that bear on questions of financial 
stability, then we are going to find a way to do that.
    Senator Heller. Thank you.
    Chairman Merkley. Thank you very much. I invite you to 
conclude just by giving us some of your thoughts on the 
challenging and complex issues related to financial stability 
and the repo market.
    Mr. Berner. OK. Thanks, Senator. The U.S. repo markets are 
really, are very important for the functioning of our financial 
system. They enable broker-dealers, investors, others, to 
finance themselves in the public market on attractive terms. 
They are used to finance securities transactions, as part of 
that nomenclature indicates, and so they facilitate financial 
transactions. They facilitate the ability of financial 
intermediaries to engage in their basic risk taking, risk 
pricing, risk management businesses. Unfortunately, as I 
indicated earlier, those markets, as we learned in the crisis, 
are subject to either runs or fire sales or both when they come 
under stress, and those markets have many investors and many 
borrowers. And so we need to look at all the investors, all the 
borrowers, and thinking about where the stress points might 
lie. In one of the three parts of the U.S. repo market, the so-
called tri-party market, there have already been put in place 
by the Federal Reserve System several reforms that are making 
that market stronger, the reduction of the intraday credit 
exposure for the institutions involved in that market, the so-
called clearing banks. But, that market is still subject to 
vulnerabilities under stress and those have been discussed 
pretty well in a variety of places, both by us and the Fed. 
There are two other parts to the market where we have--one of 
them, at least, we have very little data. That is the so-called 
over-the-counter or bilateral part of the repo market, which is 
used not to transact in the way the tri-party market works, 
through an intermediary, but directly between the borrower and 
the lender. That is an area where we have very little clarity 
and transparency about the transactions that are occurred on a 
comprehensive, systemwide basis. It is an area where we are 
working, as I indicated, with the New York Fed to collect more 
data. But it is an area where we see, potentially, as we saw in 
the crisis, even more dramatic adjustments to not just the 
willingness to provide financing, but also in the terms and 
conditions on which that financing is applied. Each of those 
areas is one in which we want to investigate as we look at 
these markets and try to figure out ways to make them more 
stable.
    Chairman Merkley. It sounds like we can anticipate that 
your next Annual Report will continue to explore these issues 
on the repo markets. I do want to thank you for your first 
appearance before the Senate Banking Committee and for the 
contribution that your research is making to the deliberations 
of the FSOC and wish you well in your quest to help fill in 
some of the data gaps and data analysis that can help us 
understand better the vulnerabilities in our system. And with 
that, I am going to adjourn the Subcommittee meeting, unless my 
Ranking Member has anything else he would like to add.
    Senator Heller. No, thank you.
    Chairman Merkley. Meeting adjourned.
    Mr. Berner. Thank you.
    [Whereupon, at 4:26 p.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
                  PREPARED STATEMENT OF RICHARD BERNER
   Director, Office of Financial Research, Department of the Treasury
                            January 29, 2014
Introduction
    Chairman Merkley, Ranking Member Heller, and Members of the 
Subcommittee, thank you for the opportunity to testify today on behalf 
of the Office of Financial Research about our 2013 Annual Report. \1\ 
This is our second report to Congress, fulfilling an annual requirement 
to assess the state of the United States financial system and analyze 
threats to U.S. financial stability.
---------------------------------------------------------------------------
     \1\ The views expressed in this testimony are those of Richard 
Berner, Director of the Office of Financial Research, and do not 
necessarily represent the views of the President.
---------------------------------------------------------------------------
    This is my first Senate hearing as OFR Director. Let me take this 
opportunity to state my commitment to make the OFR a valued resource 
for the Congress, the Financial Stability Oversight Council, and the 
American people. Our annual report and my testimony are just two ways 
we make our work known to our stakeholders. We are fully committed to 
being transparent and accountable, and I look forward to future 
opportunities to appear before you.
    My testimony today will cover the four topics cited in your 
invitation letter:

  1.  Our efforts to monitor financial stability and assess potential 
        threats to it;

  2.  The status of OFR data collection and analysis, and related data 
        security measures in place and under development;

  3.  Studies conducted and facilitated by the OFR; and

  4.  Coordination with relevant agencies.

    Before I begin that discussion, I would like to step back and 
review the core mission of the Office and the status of our efforts to 
meet it.
OFR Mission and Status
    The financial crisis revealed serious deficiencies in financial 
data and in our understanding of vulnerabilities in the financial 
system. A core part of the OFR's mission is to fill those critical gaps 
in data and analysis for the benefit of the Financial Stability 
Oversight Council (FSOC or Council) and, ultimately, the public. Our 
mandate is not to duplicate work done at other Council member agencies, 
but to complement their work--to provide the connective tissue that 
will help us look across the financial system.
    To assure transparency and accountability, we regularly engage with 
our stakeholders in several ways. Our staff regularly briefs members of 
Congress and their staffs. We also publish our studies through the 12 
papers in our Working Paper Series and our two annual reports, and make 
them available on our Web site. We have also developed our Web site to 
be user-friendly and a growing source of content. We routinely make 
public presentations to industry, academia, government, and public 
interest groups in order to share our research insights and receive 
feedback from the broader community. We invite outside experts to 
seminars to share and debate their findings and sponsor conferences to 
engage with the public. In the past year, we jointly sponsored three 
such meetings with the Council and the federal reserve banks of 
Cleveland and New York.
    The structure of the Office assures a balance between this 
transparency and accountability on one hand, and autonomy on the other. 
The OFR is an office within the Treasury Department. However, it is 
unique among Treasury offices. The integrity and independence of the 
Office's work is protected by statute. The Office serves the Council 
but is separate from it. In particular, the OFR does not make policy, 
the Council does. That puts us in an objective position to analyze 
threats to financial stability and to evaluate policies to mitigate 
them.
    To ensure objectivity, our Congressional testimony and, by 
extension, our research, must be independent. Under the statute, no 
officer or agency of the United States can require the OFR Director to 
submit Congressional testimony for approval, comment, or review prior 
to delivery to Congress.
    In creating the OFR, the Dodd-Frank Act prescribed other key 
differences from the Treasury. The OFR is funded by assessments on 
certain financial companies. The OFR's pay and employee benefits are 
comparable to those of other federal financial regulators. At the same 
time, the law requires the Director to consult on the OFR budget, 
hiring, employee compensation, and other matters with the Council 
Chair, who is the Secretary of the Treasury.
    The Office has developed rapidly during the 18 months since we 
released our first annual report. In addition to our headquarters here 
in Washington, DC, we have a satellite office in New York City to 
engage closely with market participants. Our workforce now stands at 
more than 190 employees, up from only 30 in fiscal 2011. By fiscal 
2015, we plan to reach a full staff of about 280.
    As we have grown, we have refined our management structure and our 
policies and procedures to help us carry out our mission. For example, 
we established an office of External Affairs, led by a member of our 
senior management team, to coordinate engagement with external 
stakeholders and partners in Government. Building on the strategic 
framework that we released in March 2012 to cover FY2012-14, we are 
working on a new, 5-year strategic plan to take effect in FY2015. The 
strategic goals in both plans are tied to objectives, outcomes, and 
performance measures that will focus our work and keep us accountable 
to ourselves and the public.
    We no longer talk about standing up the OFR. Today, the OFR is not 
only standing on its own, but is making important contributions to 
promote the stability of the U.S. financial system.
OFR Annual Report
    The OFR and the Council produce annual reports at 6-month 
intervals. The two reports cover similar ground but take different 
approaches. The Council report takes a comprehensive view of 
vulnerabilities and recommends ways to strengthen the financial system. 
It is a consensus report, signed by all Council members. In contrast, 
our report dives more deeply into data and research issues related to 
those vulnerabilities. We provide an independent assessment of the 
state of the U.S. financial system, although we solicit and incorporate 
feedback from Council member agencies and other subject matter experts.
    The OFR's 2013 Annual Report contains analyses that focus on 
analyzing threats to financial stability, evaluating macroprudential 
policy, presenting findings of OFR research on financial stability 
(specifically, financial contagion, market liquidity, and 
interconnections among financial institutions and markets), addressing 
data gaps and OFR's efforts to fill them, and promoting data standards, 
such as the Legal Entity Identifier. The report also discusses the 
status of the Office in achieving its mission, and concludes with our 
future research and data plans.
Monitoring Financial Stability and Potential Threats
    Thanks to an array of policy measures and industry actions, the 
U.S. financial system has grown stronger and more stable since we 
issued our inaugural annual report in July 2012. However, the financial 
crisis taught us never to be complacent about a potential buildup of 
risks that can damage the financial system and the economy. Threats to 
U.S. financial stability persist and we must remain vigilant.
    Today's environment of persistently low interest rates and low 
volatility might seem benign, but this environment can breed 
complacency. It can encourage market participants to take more risks 
and employ more leverage to achieve desired returns. Those, in turn, 
increase potential vulnerabilities to shocks, such as sharp increases 
in interest rates and jumps in volatility.
    The weaknesses in the financial system are often hidden--becoming 
obvious only when shocks expose them. Our job at the OFR is to try to 
identify and assess the vulnerabilities before shocks hit.
    We are developing a new tool--our prototype Financial Stability 
Monitor--to identify and monitor these threats and to assess the 
interplay among them. This new monitor, a heat map, tracks five 
functional areas of risk: macroeconomic, market, credit, funding and 
liquidity, and contagion. We consider this breakdown best for looking 
at risks across the financial system and identifying causes rather than 
just symptoms. We quantify risks through a mix of economic indicators, 
market indexes, and measurements that we calculate.
    This monitor is the first version of a tool that we will refine and 
improve over time. One limitation of Version 1.0 is that our current 
set of metrics largely tells us where we are, not where we are going. 
To address that, we are working to incorporate new, forward-looking 
indicators into our framework.
    Informed by this monitor, we have identified a range of potential 
threats to financial stability. The first four are closely related and 
often occur together.

  1.  Disruptions in wholesale funding markets, such as repurchase 
        agreements, or repo.

  2.  Exposure to a sudden, unanticipated rise in interest rates.

  3.  Exposure to shocks from greater risk-taking in a low-volatility 
        environment.

  4.  Exposure to a sudden shock to market liquidity.

  5.  Excessive credit risk-taking and lax underwriting standards.

  6.  Operational risk from automated trading systems, such as high-
        frequency trading.

    One additional risk is worth discussing in light of the events of 
the past week. Recently, emerging-market currency and asset markets 
have come under significant pressure, and such stress has spilled over 
quickly into global markets for risky assets, such as equities. In our 
2013 Annual Report, we highlighted emerging-market vulnerabilities, 
including those that have played out in financial markets in the last 2 
weeks. We are monitoring these developments carefully.
    In Chapter 4 of our annual report, we summarize OFR research 
projects on new tools for measuring and monitoring market liquidity 
(examining the measurement of liquidity shocks across asset classes) 
and network analysis to improve our understanding of contagion among 
financial firms exposed to each other.
    Macroprudential policies are those aimed at reducing contagion and 
other vulnerabilities that span the entire financial system. They 
address threats that cut across financial institutions and markets, and 
are designed to reduce the likelihood and severity of financial crises.
    The Dodd-Frank Act requires us to evaluate macroprudential 
policies. In Chapter 3 of the report, we outline a framework for 
evaluating such policies. Since the financial crisis, U.S. regulators 
have expanded the macroprudential toolkit, for example, through 
supervisory stress tests. Further improvement to stress tests would 
incorporate funding risks, potential spillovers, and feedback effects 
to increase value for financial stability assessments.
Data Collection, Standards, Analysis, and Security
    Filling data gaps. A key mandate for the OFR is to improve the 
scope and quality of financial data. To better measure financial 
activity and thus better understand how the financial system works--its 
interconnections, its vulnerabilities, and its risks--we are engaged in 
several projects to fill data gaps.
    A critical step in filling data gaps involves taking stock of 
existing data. To that end, we have produced and recently published the 
public portion of an Interagency Data Inventory on the OFR Web site. 
The OFR produced the inventory in collaboration with the FSOC Data 
Committee.
    The inventory is a catalog of the data that FSOC-member agencies 
collect from industry that we will update regularly. It contains a 
listing of datasets, or ``metadata,'' not the data themselves. The 
public portion posted on our Web site excludes information about 
nonpublic data, including those derived from other data.
    The inventory is essential for identifying gaps in data, avoiding 
duplication in future requests for data from industry, and improving 
research and analysis to understand threats and vulnerabilities in the 
financial system. It is thus a key building block in the OFR data 
analysis and reporting architecture.
    Chapter 5 of our annual report discusses data gaps in detail. It 
assesses gaps related to short-term funding markets and related 
financial activities, explains why filling gaps in data related to 
these markets is a top priority, and describes ways we will fill them. 
In 2014, we are working with the Federal Reserve Bank of New York to 
improve and expand data that measure activity in such markets, like 
repo and securities-lending activities.
    Data standards. High-quality data are critical for good decision 
making. Data standards are essential to assure data quality, and thus 
for comparing, aggregating, linking, and analyzing data. Their adoption 
will improve data quality and reduce collection costs and duplication.
    What are data standards? They are rules that help precisely 
identify parties to financial transactions, precisely define financial 
instruments and how they relate to one another, and precisely specify 
how data should be collected. Standards for collection specify the data 
fields for collected data and the formats in which they are collected. 
In the same way that templates are used to collect address information 
with separate fields for street, city, state, and zip code, the use of 
standards improves data management and the quality of analysis.
    We are making needed investments in the development and 
implementation of data standards. Chapter 6 of our annual report 
describes the framework we have developed for creating and promoting 
data standards. Not surprisingly, a key conclusion is that to be 
effective, standards should be adopted universally. We all need to use 
the same standards, or alternatively to be able to translate one set of 
standards smoothly into another. More work is needed, and I ask for 
your support to promote their use.
    The report also describes progress on implementing the Legal Entity 
Identifier (LEI), a global standard like a bar code for uniquely 
identifying parties to financial transactions. OFR leadership in the 
initiative to establish and promote the use of the LEI includes serving 
as Chair of the LEI's Regulatory Oversight Committee.
    The LEI's benefits are huge. Precise identification of 
counterparties would give firms a clearer picture of their exposures in 
the marketplace. Estimates from financial industry sources suggest that 
use of the LEI will save billions of dollars that the industry now 
spends on cleaning and aggregating disparate data and on reporting data 
to regulators.
    For financial regulators, the LEI would assist in data aggregation 
and comparisons, thus help in identifying vulnerabilities in the 
financial system and providing insight into ways shocks can spread 
across financial markets.
    Given those benefits, the case for universal adoption of the LEI 
system is strong. We are collaborating with primary regulators to 
achieve broader implementation of the LEI in U.S. financial reporting, 
to sync with efforts abroad. I call on regulators in the U.S. and 
around the world to require use of the LEI through regulatory 
rulemaking.
    The need for data standards also extends to financial products. For 
example, a universal mortgage identifier (UMI) is clearly needed. 
Mortgage debt represents 70 percent of U.S. household liabilities. The 
mortgage finance system is complex and the data produced by this system 
are fragmented. A single UMI would bring coherence to these data and 
would significantly benefit households, industry, regulators, and 
researchers.
    We call for the establishment of a single, cradle-to-grave, 
universal mortgage identifier that protects the privacy of the 
borrowers. With substantial input from industry and several agencies, 
we have just published an OFR working paper that discusses the 
characteristics that a UMI should have and criteria for implementation.
    Industry participants strongly favor the LEI and the UMI to help 
make their internal data and their reporting activities coherent and 
efficient.
    In another initiative, we are engaging with the Commodity Futures 
Trading Commission (CFTC) to design and use standards to improve the 
quality of data collected from trade and swap data repositories.
    Data analysis. Our annual report contains preliminary results of 
OFR research using newly available, highly granular data. For example, 
our analysis of money market fund investments enables us to assess the 
factors triggering the large decline in U.S. money fund holdings of 
European bank liabilities during the European sovereign debt crisis. An 
analysis of the sovereign credit default swap market enables us to 
identify the sellers, market makers, and buyers of credit protection, 
and thus to locate sources of risk. We also analyzed hedge fund 
leverage using aggregated data from Form PF. These aggregated data 
suggest that hedge fund use of leverage is inversely related to the 
liquidity of, and the risks in, assets in the funds' portfolios.
    Data security. No OFR goal is more important than safely and 
securely collecting data and safeguarding the data we hold.
    OFR information security standards are governed by those of the 
Treasury, and our Chief Information Security Officer works closely with 
his Treasury counterpart to assure that our policies and procedures 
meet or exceed the standards of the Treasury Department, as well as the 
standards of Council member organizations.
    To support OFR staff research and to clean, manage, and store 
large-scale datasets, we have made substantial progress in building our 
technological infrastructure and the analytical environment that will 
house our data and give our researchers the advanced tools they need to 
conduct innovative research.
    Our information security standards are fundamental to this new 
technology infrastructure, verifying access permissions at the most 
granular level. Technology is necessary but insufficient alone to 
assure security, so the systems we are building for data acquisition, 
management, and dissemination are accompanied by strict and clear rules 
for data security and data sharing.
    As required by the Federal Information Security Management Act, the 
Office has established an information security program policy and data 
handling procedures for proper safekeeping of information at the 
highest level of the Federal Information Processing Standards. Our 
program also includes postemployment restrictions for employees who 
handle sensitive information.
    In addition, we are expanding security controls for sharing 
information among Council member agencies, collaborating to forge 
bilateral data-sharing agreements to assure all participants that 
shared data will be protected, secured, and treated consistently. The 
agreements are consistent with the analysis of Council data sharing by 
the Council of Inspectors General for Financial Oversight.
    For data-sharing agreements to work, agencies must agree on 
information security classifications and how to apply them. For 
example, different agencies may have had different policies for 
handling data defined as ``restricted'' or ``high security.'' The 
Office led an initiative by the Council Data Committee to ``crosswalk'' 
security classification categories. An interagency working group 
established a common framework for information security practices, 
processes, and compliance requirements.
    The National Institute of Standards and Technology assisted the 
working group in aligning the framework with the Federal Information 
Security Management Act of 2002 and the Federal Information Protection 
Standards. These federal standards represent the common base to which 
all federal agency classifications are mapped.
OFR Studies Conducted and Facilitated
    The OFR has conducted and facilitated a wide range of studies in 
support of its mission. For example, our Working Paper Series is 
designed to inform the process of assessing, measuring, monitoring, and 
mitigating threats to financial stability. In addition to the paper 
about the Universal Mortgage Identifier, discussed above, we have 
released a paper assessing contagion in financial networks and several 
papers on the theory and practice of stress testing.
    The OFR has also conducted analysis for the last two FSOC annual 
reports. We have also facilitated analysis for the Council, such as 
evaluating the risks of money market funds and data related to the 
process of designating nonbanks for supervision by the Federal Reserve.
    In the international arena, the OFR contributes to work streams of 
the Financial Stability Board on ways to improve data quality in swap 
data repositories and data gaps in shadow banking.
    In September 2013, we released Asset Management and Financial 
Stability, a report on asset management summarizing the results of a 
study requested by the Council. We designed the report to inform the 
Council's consideration of what threats in asset management activities 
exist and what remedies, if any, might be appropriate to mitigate any 
such threats.
    The report had three key findings:

    Asset management activities and firms differ from banking 
        activities and banks. To quote the first page of the report, 
        asset management activities ``differ in important ways from 
        commercial banking and insurance activities. Asset managers act 
        primarily as agents: managing assets on behalf of clients as 
        opposed to investing on the managers' behalf. Losses are borne 
        by--and gains accrue to--clients rather than asset management 
        firms. In contrast, commercial banks and insurance companies 
        typically act as principals: accepting deposits with a 
        liability of redemption at par and on demand, or assuming 
        specified liabilities with respect to policy holders.''

    Vulnerabilities in some activities could give rise to 
        threats to financial stability, in particular, risk-taking in 
        separately managed accounts and the reinvestment of cash 
        collateral in securities lending transactions.

    Significant data gaps hamper analysis. Filling them would 
        be essential to verifying our findings.

    It is also important to note what the report did not do:

    It did not evaluate individual firms. Any designation 
        process by the FSOC would involve evaluation of individual 
        firms. The OFR report did not focus on individual firms, but 
        instead on asset management activities. As a result, the OFR 
        report alone could not be used as the basis for designating any 
        particular firm.

    It did not substitute for the Council's work. The goal of 
        the report was to provide information. The Dodd-Frank Act 
        established the OFR as a research and data organization with 
        the mandate to support the Council and its member agencies in 
        their efforts to identify and mitigate threats to financial 
        stability. Responding to the Council's request for this 
        analysis is part of fulfilling that mandate. However, the OFR's 
        responsibilities do not extend to deciding on policy actions. 
        The OFR Director is a nonvoting member of the Council and only 
        the voting members of the Council decide on the specific 
        threats posed by any activity and whether any remedies are 
        necessary to mitigate such threats.

    Finally, it is important to note that the OFR followed an open and 
transparent process in gathering information for the report:

    The OFR research team met with representatives from the 
        asset management industry on numerous occasions. Not only did 
        we grant every request from the industry to meet, but we 
        actively sought meetings with industry representatives to learn 
        as much as possible about industry business models and 
        practices.

    The OFR research team engaged with experts from FSOC member 
        agencies throughout the entire course of the process, including 
        extensive interaction with experts from the Securities and 
        Exchange Commission (SEC). Many important contributions from 
        those experts appear verbatim in the report.

    Sponsoring research. We do not conduct our research and analysis in 
a vacuum. On the contrary, we seek to create a virtual research 
community to promote and sponsor world-class research by exchanging and 
testing ideas. The conferences, workshops, seminars, and public 
appearances that I mentioned earlier serve as incubators for generating 
new ideas about promoting financial stability and making our financial 
system safer.
    Another such incubator is our Financial Research Advisory 
Committee, 30 distinguished professionals in economics, data 
management, risk management, information technology, and other fields 
who provide expert advice to the OFR and bring diverse perspectives to 
help the OFR fulfill its mission. In August 2013, the committee 
submitted its first set of recommendations to the OFR; these 
recommendations and the proceedings of the Committee are posted on our 
Web site.
    We have also established a program for sponsoring research through 
grants. In May 2013, we announced our partnership with the National 
Science Foundation to sponsor novel research related to financial 
stability. The first grant was awarded in September 2013 for a project 
to examine the impact of high-speed trading on the financial system. 
This research promises to yield additional insights into working with 
extremely large financial datasets in a supercomputing environment. 
Researchers at the University of Illinois at Urbana-Champaign and the 
San Diego Supercomputing Center are conducting the research.
Coordination With Relevant Agencies
    Interagency coordination is part of the OFR's every day routine in 
engaging with FSOC member agencies and others. Examples include our 
extensive coordination with relevant agencies on our asset management 
report, on data sharing, in seeking input from agencies on other 
research-related publications, and in providing subject-matter 
expertise to them.
    The OFR leads the FSOC's Data Committee, which handles issues 
related to data collection, gaps, and standards. We are also supplying 
data and analysis to the FSOC Systemic Risk Committee and the Nonbank 
Designation Committee.
    Before publishing a research working paper or annual report, we 
solicit feedback from subject matter experts in academia and at FSOC 
member agencies and other financial regulators, such as the Federal 
Reserve Bank of New York.
    We are also collaborating with the SEC on cleaning and analyzing 
data from Form PF, which is submitted by hedge funds and other private 
funds and, as I mentioned, we are engaging with the CFTC to improve the 
quality of data reported to swaps data repositories.
    As I already mentioned, we are also collaborating with Council 
member agencies through the Council's Data Committee to promote data 
sharing, consistent with the strictest security measures.
Conclusion
    As the financial system changes, evolves, and innovates, new 
threats and vulnerabilities continuously emerge. At the OFR, we face 
the challenge every day of filling gaps in data, and conducting and 
sponsoring essential research that will help us not only understand the 
financial system of today, but also identify the vulnerabilities that 
could ensnare our financial system and economy tomorrow.
    It is critical for Congress and the American people to receive 
timely and accurate information about our essential work. That is what 
makes venues such as this hearing so important.
    Thank you again for the opportunity to appear today. I would be 
happy to respond to your questions.

        RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
                      FROM RICHARD BERNER

Q.1. What additional disclosures, reporting, limits, or other 
actions could mitigate concerns about asset manager exposures 
in the derivatives market?

A.1. As we noted in our Asset Management Report and our recent 
Annual Report, the OFR is working with the SEC and other 
members of the Council to analyze the Commission's Form PF in 
an effort to understand and address remaining data gaps and 
improve disclosures in asset management activities. In 
addition, the OFR is working with the CFTC to identify ways to 
improve the quality of the data describing derivatives 
transactions and exposures that are being collected by swaps 
data repositories, and is also engaged on the international 
level to better align swaps data collections to provide a more 
precise and coherent global view of these markets.
    Higher-quality data are needed to improve the understanding 
of exposures in both derivatives markets and in the securities 
lending and repo activities described in the response to the 
next question. The OFR believes that implementation of a common 
data template would help improve data quality; it should meet 
the following requirements:

    The data template should be based on a clear 
        dictionary of data definitions to ensure effective and 
        consistent data aggregation across multiple types of 
        market participants;

    reporting periods should be consistent across all 
        firms where feasible;

    reporting frequency and timeliness should ensure 
        that potential market dislocations are captured;

    data elements should provide the common minimum set 
        of standards for U.S. regulatory agencies.

    Any such data initiatives should also be designed with 
consideration of market structure and scale, and should build 
upon existing data collection processes and market 
infrastructures. For example, collecting transactions-level 
data for exchange-traded derivatives may be best accomplished 
through financial market utilities, including swap data 
repositories.
    The OFR has not conducted analysis of potential mitigating 
actions that regulators could take in this area.

Q.2. What elements should be included in any reporting 
requirements pursuant to Section 984 to fully inform regulators 
of the risks involved in securities lending activities? Would a 
rule under Section 984 require disclosure on all types of 
securities lending and all relevant parties, or could holes 
remain?

A.2. The OFR is seeking to close the data gaps related to both 
securities lending and repo activities; they have many features 
in common. Steps in that project include ongoing analysis of 
the short-term funding markets, input from the largest and most 
interconnected market players, and, involvement in other 
efforts to learn more about the securities lending activities 
managed by the largest custodian banks.
    Additional disclosure requirements could be helpful. These 
could include information on the type of securities lent, the 
amount of cash collateral held related to securities lending 
and how it is managed, rebates paid to securities borrowers, 
the percentage of securities for which the firm provides an 
indemnity in the event a borrower is unable to return the 
security, securities borrowed, and counterparties the asset 
manager works with for securities lending transactions.

Q.3. Have prudential regulators expressed concerns about the 
types and concentration of reinvestment of cash collateral 
undertaken by securities lenders? If yes, does OFR plan to work 
with these regulators to address concerns about reinvestment of 
cash collateral? If not, do regulators feel that cash 
collateral reinvestment practices are sufficiently sound to 
protect both fund assets and securities borrowers, and does OFR 
agree with this assessment?

A.3. Since the financial crisis, the scope of securities 
lending activities has decreased substantially. Many lenders 
who sustained losses have exited their securities lending 
programs. Collateral reinvestment practices have been reviewed 
to ensure better risk management. Nevertheless, U.S. regulators 
continue to express concern about cash collateral reinvestment 
activities undertaken by securities lenders--see for instance 
the FSOC 2013 Annual Report (pages 68 and 144) and 
contributions to reports from the Financial Stability Board. 
The concern stems from two sources: First, that under stress, 
such reinvestment transactions might be unwound quickly, 
resulting in fire-sale conditions; and second, that regulatory 
agencies lack reliable, detailed data on reinvestment 
activities and specific investment practices. The OFR's 
analysis of market sources indicates that reinvestment 
practices vary widely. We will continue to investigate and 
monitor these issues and we will work with regulators to 
address their concerns.
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