Hensarling's effort to close financial research office a big mistake

Hensarling's effort to close financial research office a big mistake
© Camille Fine

The Office of Financial Research (OFR), created in the Dodd-Frank legislation, was tasked with improving financial data available to the government so that threats to financial stability can be better assessed.

Dino Falaschetti, chief economist at the House Financial Services Committee, was recently nominated to head the office. Falaschetti’s current boss, House Financial Services Committee Chairman Jeb HensarlingThomas (Jeb) Jeb HensarlingRare bipartisanship in lame duck Congress battling the ‘WTO’ of insurance regulation On The Money: Markets roiled by trade tensions | Rally on hopes of Fed pause on rate hikes | Senate sends two-week spending measure to Trump | Consumer bureau pick confirmed | Trade deficit at highest level since 2008 McHenry to lead GOP on banking panel, duel with Maxine Waters MORE (R-Texas), has long advocated for abolishing the OFR.

Hensarling’s rationale for eliminating the OFR focused on its economic analysis function, which he and other sponsors of The Financial CHOICE Act, a replacement for the Dodd Frank legislation, claimed is duplicative of analysis done by other federal agencies.

The House in May accepted the Senate’s milder Dodd-Frank reform bill, the Economic Growth, Regulatory Relief, and Consumer Protection Act, which left in place the OFR. Trump administration efforts to reign in financial regulations has led to a 25-percent budget reduction and a headcount reduction of one-third for the OFR.

It would seem the nominated director has been sent on a mission to remove the economic analysis functions conducted at the OFR in favor of existing analysis done by multiple federal agencies.

What is less understood about the OFR's work is the OFR’s key role in driving data standards throughout the financial system, with much done and more to be accomplished. It would be a significant blow to four decades of attempts at global data standards if the OFR was not permitted to continue its role in this significant undertaking.

Data standards, particularly identity data, are a fundamental requirement for organizing data to allow more granular, less error-prone financial, economic and risk analysis.

The financial crisis that erupted in September 2008 taught us a very hard lesson when regulators, creditors, counterparties, forensic accountants and bankruptcy lawyers had no line of sight on institutional and counterparty risk at Lehman Brothers or at any other major financial firm.

Even corporate clients who had accounts with Lehman could not verify its positions nor even understand in what capacity they were doing business with the firm. They certainly had no way of assessing the risk of a Lehman bankruptcy.

One of the reasons for the creation of the Office of Financial Research was to establish an identification system to provide regulators with the means to aggregate risk at a more granular level across multiple financial institutions and across economies.

This was to be done so that government agencies and financial industry members could see the risk building up before it came to the point of crisis. Government involvement was thought necessary to overcome the industry’s collective action problem as each firm by itself was incapable of solving this global problem.

Data sent from, or to, government agencies or financial institutions use separate identity codes and data formats for what should be identical information.

In the U.S., reports from each of 15 federal financial agencies, 50 separate state financial agencies and thousands of financial institutions, data vendors, academic institutions, analysts, etc. use hundreds of different codes for the same legal entity.

To this end, the OFR’s first initiative was to champion a global legal entity identifier (the LEI), a simple code that would be assigned universally to every financial market participant. It would subsequently become the center-piece of a data standards initiative now led at the global level by the Group of 20’s Financial Stability Board.

To date, 1.2 million LEIs have been issued, through 91 separate pieces of legislation overseen by a global committee of 70 financial regulators.

This global initiative now includes data standards for financial instruments and contracts, financial transactions and a set of common data elements that make up the component parts of financial transactions.

These standards are essential to analyzing the potential of a market or credit disruption. They are foundational elements in aggregating data across global financial institutions to observe the contagion of systemic risk.

Regulators now make similar reporting demands on each financial institution, forcing them to send data separately to each regulator.

The mission of the OFR was to provide a set of data standards for financial institutions and agencies, the same set of standards, so that reporting can be streamlined, can be provided for at a more granular level and reported only once. Thereafter, each agency can provide its own analysis relying on the same data sets.

To realize this objective, we need the OFR to continue its standards initiatives in the U.S. and be the contact point to foster global adoption of these standards. Sustaining the U.S. government's interest in financial industry data standards without the OFR may leave the various government financial agencies to their own regulatory silo self-interests and abandon this global initiative.

Data standardization has more benefits than just providing tools for more granular analysis. It is critical to replacing the costly, risk-prone, decades-old interoperability models that dominate the financial industry.

This model requires separate reconciliation and mapping processes between each hand-off and connection point for the hundreds of proprietary identity standards that exist. Huge infrastructure costs and risk are embedded in this process.

Also newer technologies cannot function efficiently, if at all, without standardized data. The hope is that the director nominee sees the criticality of the OFRs data standards mission, preserves it and can transform the OFR from its economic analysis mission to its data science destiny.

Allan Grody is the president of Financial InterGroup Advisors — strategists, consultants and researchers in financial services with particular focus on bank regulation and the design and implementation of innovative enterprise solutions. Grody is also an editorial board member of the Journal of Risk Management in Financial Institutions.