Senate Banking Hearing on Capital Formation Bills
Senate Banking Subcommittee on Securities, Insurance, and Investment
“Interest on Reserves and the Fed’s Balance Sheet”
Thursday, May 19, 2016
Key Topics & Takeaways
- Floating NAV Bill: Sens. Robert Menendez (D-N.J.) and Joe Donnelly (D-Ind.) asked similar questions about what other financing options exist if state and local governments face impeded access to capital markets because of the closure of MMFs due to floating NAV requirements. Crane replied that governments would face much higher costs by turning to the bond market or to bank financing.
- BDC Bill: Sen. Elizabeth Warren (D-Mass.) attacked the ability of BDCs to invest in financial services companies, and criticized the bill as a whole as a “giveaway” to BDC executives that is “masquerading” as a small business capital formation bill.
Witnesses
- Ron Crane, Idaho State Treasurer
- Michael Arougheti, Ares Capital Formation; on behalf of the Small Business Investor Alliance
- Stephen Hall, Better Markets
- Drew Fung, Clarion Partners; on behalf of the Commercial Real Estate Finance Council
Legislation Discussed
- S. 1802, the Consumer Financial Choice and Capital Markets Protection Act
- H.R. 3868, the Small Business Credit Availability Act
- H.R. 4620, the Preserving Access to CRE Capital Act
Opening Statements
In his opening statement, Chairman Mike Crapo (R-Idaho) said there is growing concern that pending and existing federal rules are restricting access to capital, and commented on the importance of Congress understanding the impacts of regulations on businesses and communities. He noted that the House Financial Services Committee has already considered H.R. 3868, the Small Business Credit Availability Act, and H.R. 4620, the Preserving Access to CRE Capital Act.
Ranking Member Mark Warner (D-Va.) said that while work is needed to improve capital formation, any proposals must avoid harm to investors or the financial system broadly. He noted his particular interest in H.R. 3868, but commented that he is concerned that the bill would allow business development companies (BDCs) to invest more in financial services companies and registered investment advisors. He was critical of H.R. 4620, stressing the importance of maintaining the principle of aligning the interests of investors and securitizers, and of S. 1802, the Consumer Financial Choice and Capital Markets Protection Act, commenting that he has grave concerns about returning to a stable net asset value (NAV) from the requirement for a floating NAV for prime and tax-exempt money market funds (MMFs).
Sen. Pat Toomey (R-Pa.) stated that the economy has been underperforming for years in part due to overregulation. He spoke in support of his bill, S. 1802, stressing that taxpayers never had to bail out MMFs and yet stringent new requirements from the Securities and Exchange Commission (SEC) are now “problematic for a number of reasons.” He also offered praise for H.R. 3868, remarking on the importance of BDCs to financing for small companies and calling the proposal “very constructive legislation.”
Sen. Robert Menendez (D-N.J.) commented that he has always been concerned about ensuring access to capital for state and local governments, and that MMFs have traditionally facilitated this access by investing in short-term municipal debt and holding it to maturity. He said he has heard from a number of elected officials that access to capital is now at risk because of unintended consequences of the SEC’s rule regarding floating NAV calculations. He warned that if investors leave MMFs, then borrowing costs for state and local governments will rise.
Testimony
Ron Crane, Idaho State Treasurer
In his testimony, Crane said the implementation of floating NAV is leading a great deal of money to leave MMFs, which leaves these funds unable to support communities and businesses. He defended stable NAV as having been a stable source of financing for decades, and praised S. 1802 for addressing this issue while also noting that the bill leaves all other MMF reforms in place.
Michael Arougheti, Ares Capital Formation; on behalf of the Small Business Investor Alliance
Arougheti, in his testimony, spoke of the importance of BDCs in funding small and emerging companies, especially as commercial banks have withdrawn from lending to this sector. He pointed out that BDCs are highly regulated and provide full transparency to investors, regulators and portfolio companies, with publicly-traded BDCs subject to SEC disclosure requirements and other rules. He said H.R. 3868 would modernize BDC regulation by allowing a modest increase in leverage to a level still well-below leverage ratios in banking, and added that increasing leverage will require either a shareholder vote or a vote by the board of directors.
Stephen Hall, Better Markets
In his testimony, Hall warned that deregulation undermines capital formation by eroding investor confidence and increasing the likelihood of financial crises. He called S. 1802 “a step in the wrong direction” and stated that the 2008 crisis showed that MMFs are susceptible to runs. On H.R. 4620, he cautioned that the originate-to-distribute model became pervasive before the crisis, including in commercial real estate, and that the bill makes counterproductive changes that dilute the criteria for qualified commercial real estate (CRE) loans. Finally, he insisted that H.R. 3868 will undermine financial safeguards by allowing BDCs to double their leverage, and pointed out that the bill would also allow these companies to invest more in financial companies rather than the small companies they were intended to support.
Drew Fung, Clarion Partners; on behalf of the Commercial Real Estate Finance Council
Fung, in his testimony, discussed the importance of commercial mortgage-backed securities (CMBS) as a financing tool in real estate, and remarked that a plethora of new rules have affected CMBS liquidity and undermined this funding source. He noted that there are eight new capital and liquidity rules, including risk retention rules, and four more being developed that impact CMBS. Fung said it is important to consider the aggregate impact of these rules, and he hailed H.R. 4620 for adjusting the criteria for loans to be exempted from risk retention rules.
Questions and Answers
S. 1802, the Consumer Financial Choice and Capital Markets Protection Act
Warner commented that the SEC’s rule on floating NAV was a compromise, and that he appreciates the fact that floating NAV puts across the notion that there are risks with MMFs.
Toomey asked if there is any data to indicate the “entire wave” of new regulations on MMFs, absent the floating NAV, is inadequate. Hall answered that studies have shown MMFs have teetered on collapse “hundreds of times” and would have fallen apart without sponsorship support. He said there has been analysis to support floating NAV, including the SEC’s economic analysis.
Toomey responded that he still questions whether there is reliable data to support floating NAV.
Menendez and Sen. Joe Donnelly (D-Ind.) asked similar questions about what other financing options exist if state and local governments face impeded access to capital markets because of the closure of MMFs. Crane replied that governments would face much higher costs by turning to the bond market or to bank financing.
H.R. 3868, the Small Business Credit Availability Act
Warner commented that while he is sympathetic to increasing BDCs’ leverage so that they can support more small companies, but that he does not see the merit in increasing their ability to invest in financial institutions. Hall said H.R. 3868 is an overhaul of the BDC regime rather than a modest adjustment as some have stated. He pointed to recent reports that he said show BDCs are facing challenges with their leverage ratios as they stand today.
Arougheti retorted that the reports Hall mentioned described struggles because of constraints on leverage, not because of leverage being too high. He also defended investments in financial companies, offering that many of the financial firms BDCs invest in have similar mandates to support small companies.
Sen. Bob Corker (R-Tenn.) asked what drives BDCs’ interest in investing in financial institutions. Arougheti explained that the economy has changed, with financial services companies representing a larger part of the economy and being job creators themselves.
Sen. Elizabeth Warren (D-Mass.) was very critical of the BDC model, suggesting that large BDCs charge high management and incentive fees to small retail investors “who don’t realize they are being fleeced.”
Warren also attacked the ability of BDCs to invest in financial services companies, and criticized the bill as a whole as a “giveaway” to BDC executives that is “masquerading” as a small business capital formation bill.
For more information on this hearing, please click here.
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Senate Banking Subcommittee on Securities, Insurance, and Investment
“Interest on Reserves and the Fed’s Balance Sheet”
Thursday, May 19, 2016
Key Topics & Takeaways
- Floating NAV Bill: Sens. Robert Menendez (D-N.J.) and Joe Donnelly (D-Ind.) asked similar questions about what other financing options exist if state and local governments face impeded access to capital markets because of the closure of MMFs due to floating NAV requirements. Crane replied that governments would face much higher costs by turning to the bond market or to bank financing.
- BDC Bill: Sen. Elizabeth Warren (D-Mass.) attacked the ability of BDCs to invest in financial services companies, and criticized the bill as a whole as a “giveaway” to BDC executives that is “masquerading” as a small business capital formation bill.
Witnesses
- Ron Crane, Idaho State Treasurer
- Michael Arougheti, Ares Capital Formation; on behalf of the Small Business Investor Alliance
- Stephen Hall, Better Markets
- Drew Fung, Clarion Partners; on behalf of the Commercial Real Estate Finance Council
Legislation Discussed
- S. 1802, the Consumer Financial Choice and Capital Markets Protection Act
- H.R. 3868, the Small Business Credit Availability Act
- H.R. 4620, the Preserving Access to CRE Capital Act
Opening Statements
In his opening statement, Chairman Mike Crapo (R-Idaho) said there is growing concern that pending and existing federal rules are restricting access to capital, and commented on the importance of Congress understanding the impacts of regulations on businesses and communities. He noted that the House Financial Services Committee has already considered H.R. 3868, the Small Business Credit Availability Act, and H.R. 4620, the Preserving Access to CRE Capital Act.
Ranking Member Mark Warner (D-Va.) said that while work is needed to improve capital formation, any proposals must avoid harm to investors or the financial system broadly. He noted his particular interest in H.R. 3868, but commented that he is concerned that the bill would allow business development companies (BDCs) to invest more in financial services companies and registered investment advisors. He was critical of H.R. 4620, stressing the importance of maintaining the principle of aligning the interests of investors and securitizers, and of S. 1802, the Consumer Financial Choice and Capital Markets Protection Act, commenting that he has grave concerns about returning to a stable net asset value (NAV) from the requirement for a floating NAV for prime and tax-exempt money market funds (MMFs).
Sen. Pat Toomey (R-Pa.) stated that the economy has been underperforming for years in part due to overregulation. He spoke in support of his bill, S. 1802, stressing that taxpayers never had to bail out MMFs and yet stringent new requirements from the Securities and Exchange Commission (SEC) are now “problematic for a number of reasons.” He also offered praise for H.R. 3868, remarking on the importance of BDCs to financing for small companies and calling the proposal “very constructive legislation.”
Sen. Robert Menendez (D-N.J.) commented that he has always been concerned about ensuring access to capital for state and local governments, and that MMFs have traditionally facilitated this access by investing in short-term municipal debt and holding it to maturity. He said he has heard from a number of elected officials that access to capital is now at risk because of unintended consequences of the SEC’s rule regarding floating NAV calculations. He warned that if investors leave MMFs, then borrowing costs for state and local governments will rise.
Testimony
Ron Crane, Idaho State Treasurer
In his testimony, Crane said the implementation of floating NAV is leading a great deal of money to leave MMFs, which leaves these funds unable to support communities and businesses. He defended stable NAV as having been a stable source of financing for decades, and praised S. 1802 for addressing this issue while also noting that the bill leaves all other MMF reforms in place.
Michael Arougheti, Ares Capital Formation; on behalf of the Small Business Investor Alliance
Arougheti, in his testimony, spoke of the importance of BDCs in funding small and emerging companies, especially as commercial banks have withdrawn from lending to this sector. He pointed out that BDCs are highly regulated and provide full transparency to investors, regulators and portfolio companies, with publicly-traded BDCs subject to SEC disclosure requirements and other rules. He said H.R. 3868 would modernize BDC regulation by allowing a modest increase in leverage to a level still well-below leverage ratios in banking, and added that increasing leverage will require either a shareholder vote or a vote by the board of directors.
Stephen Hall, Better Markets
In his testimony, Hall warned that deregulation undermines capital formation by eroding investor confidence and increasing the likelihood of financial crises. He called S. 1802 “a step in the wrong direction” and stated that the 2008 crisis showed that MMFs are susceptible to runs. On H.R. 4620, he cautioned that the originate-to-distribute model became pervasive before the crisis, including in commercial real estate, and that the bill makes counterproductive changes that dilute the criteria for qualified commercial real estate (CRE) loans. Finally, he insisted that H.R. 3868 will undermine financial safeguards by allowing BDCs to double their leverage, and pointed out that the bill would also allow these companies to invest more in financial companies rather than the small companies they were intended to support.
Drew Fung, Clarion Partners; on behalf of the Commercial Real Estate Finance Council
Fung, in his testimony, discussed the importance of commercial mortgage-backed securities (CMBS) as a financing tool in real estate, and remarked that a plethora of new rules have affected CMBS liquidity and undermined this funding source. He noted that there are eight new capital and liquidity rules, including risk retention rules, and four more being developed that impact CMBS. Fung said it is important to consider the aggregate impact of these rules, and he hailed H.R. 4620 for adjusting the criteria for loans to be exempted from risk retention rules.
Questions and Answers
S. 1802, the Consumer Financial Choice and Capital Markets Protection Act
Warner commented that the SEC’s rule on floating NAV was a compromise, and that he appreciates the fact that floating NAV puts across the notion that there are risks with MMFs.
Toomey asked if there is any data to indicate the “entire wave” of new regulations on MMFs, absent the floating NAV, is inadequate. Hall answered that studies have shown MMFs have teetered on collapse “hundreds of times” and would have fallen apart without sponsorship support. He said there has been analysis to support floating NAV, including the SEC’s economic analysis.
Toomey responded that he still questions whether there is reliable data to support floating NAV.
Menendez and Sen. Joe Donnelly (D-Ind.) asked similar questions about what other financing options exist if state and local governments face impeded access to capital markets because of the closure of MMFs. Crane replied that governments would face much higher costs by turning to the bond market or to bank financing.
H.R. 3868, the Small Business Credit Availability Act
Warner commented that while he is sympathetic to increasing BDCs’ leverage so that they can support more small companies, but that he does not see the merit in increasing their ability to invest in financial institutions. Hall said H.R. 3868 is an overhaul of the BDC regime rather than a modest adjustment as some have stated. He pointed to recent reports that he said show BDCs are facing challenges with their leverage ratios as they stand today.
Arougheti retorted that the reports Hall mentioned described struggles because of constraints on leverage, not because of leverage being too high. He also defended investments in financial companies, offering that many of the financial firms BDCs invest in have similar mandates to support small companies.
Sen. Bob Corker (R-Tenn.) asked what drives BDCs’ interest in investing in financial institutions. Arougheti explained that the economy has changed, with financial services companies representing a larger part of the economy and being job creators themselves.
Sen. Elizabeth Warren (D-Mass.) was very critical of the BDC model, suggesting that large BDCs charge high management and incentive fees to small retail investors “who don’t realize they are being fleeced.”
Warren also attacked the ability of BDCs to invest in financial services companies, and criticized the bill as a whole as a “giveaway” to BDC executives that is “masquerading” as a small business capital formation bill.
For more information on this hearing, please click here.