Remarks by James Martin at the 2022 Financial Stability Conference
Published: November 18, 2022
Thank you, Dasol, for your kind introduction. I am delighted to kick off day two of the Financial Stability Conference.
The frontier risk theme could not be timelier, and I look forward to the paper presentations and panel discussions that will explore these issues. In keeping with the conference’s theme, I will discuss how the OFR plans to tackle two frontier risks: The growth in digital assets - which lately feels less remote and frontier - and the threat to the financial system posed by climate change. I’ll conclude with our efforts to address instability in Treasury markets that, as you know, is not a novel risk, but one where gaps in data remain.
But before I begin, I want to thank President Loretta Mester, senior economic and policy advisor Joe Haubrich, and the staff of the Cleveland Fed for all their hard work in putting together this conference with us, and for their dedication to advancing financial stability analysis and monitoring.
Risks to financial stability often emerge from traditional sources, such as from changes in fiscal, monetary, and regulatory policies. Markets and institutions are also confronted by frontier risks that pose new challenges for regulators. Each risk is unique and each stems from a different source, such as rapid advancements in technology, changes in the physical environment, and global interlinkages.
When shocks borne by these risks hit, the financial system must withstand them and continue to facilitate economic activity. But to ensure financial system resiliency in the face of these growing threats, we need to act now. We need to be forward looking, but also not forget the lessons of our past.
Specifically, we need to be creative and holistic in our research to spot hidden interconnections. We need to identify and fill data gaps so those who are analyzing frontier risks have a more complete picture. And we need to integrate data on frontier risks with traditional financial data to better monitor their threat to the financial system.
That is work the OFR is focused on, and that is what I will discuss with you today.
The growth in digital assets is a frontier risk borne by technological innovation. But as we’ve experienced, innovations that remain unchecked or loosely regulated can pose risks to the stability of the U.S. financial system.
Therefore, the OFR is evaluating the risks digital assets could pose from several angles.
Authors of the OFR’s most recent research on digital assets created a unique dataset to quantify digital asset market growth over the past several years and map exposures major players have to each other. The authors found high growth and high concentration in the digital assets market.
A working paper we published in July, Central Bank Digital Currency: Stability and Information, looks at one financial stability risk stemming from digital assets—liquidity risks related to run-like behavior by investors—and found this particular risk may not be as big as initially feared. A complementary piece we expect to publish in the coming months, however, found banking-sector stability may suffer when digital currencies are fully integrated into the financial system.
To further our analysis, we are inventorying what commercial data is available on digital assets, and also engaging in discussions with federal and state financial regulators on where there are gaps in data on digital assets and how to best fill them.
Climate change is a frontier risk borne by changes in the physical environment as well as regulatory changes to address those challenges. It is an increasing threat to financial stability and being able to assess it accurately is vital to mitigating it. But as you may have experienced, climate risk is complicated to define, and its potential risk to the financial system is challenging to model and forecast.
Producing high-quality research on climate risk requires access to both climate and financial data, as well as the ability to integrate these data. The integration can be complicated since it requires high-powered computing to ingest large, often complex data sets, as well as advanced statistical software to integrate these data. While we’ve heard anecdotally this integration is a challenge for many researchers, we know firsthand that it is something financial regulators struggle with.
Earlier this year, the OFR partnered with our colleagues at the Federal Reserve Board to test a collaboration space equipped with data, high-powered computing, and analytic tools. This prototype environment provided select staff from the OFR and the Federal Reserve System access to climate data—such as figures on precipitation, and crop and atmospheric conditions—and also provided the tools needed to integrate this data with the Federal Reserve’s supervisory financial data. The environment was also equipped with applications for users to collaborate on research and share their findings.
Climate-related data was the focus for the pilot use of the environment. Given the success of this pilot, the OFR is moving this test space into full production. The new environment will support financial stability research by providing a platform to integrate and analyze a broad spectrum of data. Looking ahead, we hope to expand this collaborative space for use by other FSOC regulators and to include additional data.
Let me wrap up by discussing a risk that is not a frontier risk, but one that routinely is in scrutiny–Treasury market liquidity. Similar to frontier risks, we must act now to ensure the financial system can withstand such stress.
In March 2020, the Treasury market—often considered the safest and most liquid market in the world—experienced extreme stress. While this took many by surprise, it was not unprecedented. Research published by the OFR in June 2022 showed that many of the vulnerabilities present in the 2020 episode paralleled those of a previous episode of stress.
Stress in Treasury markets spilled into short-term funding markets, such as the U.S. repurchase agreement (repo) market. For years, regulators have called for greater insight and transparency into the repo market. The OFR closed part of this data gap in 2019 by collecting data on centrally cleared transactions and has now turned its attention to the non-centrally cleared bilateral segment. This segment of the repo market—where repo transactions are conducted between two firms without the involvement of a central counterparty or triparty custodian—is a blind spot for regulators.
Earlier this year, the OFR went directly to the industry to learn more about this opaque market. We engaged in a series of discussions about how non-centrally cleared bilateral trades are conducted and documented. We gathered data on non-centrally cleared bilateral repo transactions from nine institutions that kindly volunteered to share a snapshot of their data with us. This work represents the first step toward permanent data collection by the OFR in this crucial market segment.
As the financial system changes, evolves, and innovates, new threats and vulnerabilities are ever emerging.
The OFR is addressing these challenges head on, every day, by identifying and filling gaps in data and conducting 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.
The job is massive and challenging, and we need the help of people like you in this room. Thank you for your research into these pressing risks, and for sharing your insights at this conference.
James Martin is the Deputy Director of Operations performing the duties of the Director