Transparency in Financial Benchmarks and commodity prices by Richard Field (full bio below)
In the first article in this series, A Brief History of Transparency, I explained how the global financial system came to be based on disclosure and the idea investors should know what they own or are thinking of buying. The responsibility for ensuring disclosure equivalent to valuing the contents of a clear plastic bag and not a brown paper bag was given to regulators. As shown by our recent financial crisis, this was a design flaw. Why did the financial regulators fail to require disclosure so investors could have the transparency of a clear plastic bag in every corner of the global financial system? While we will never know exactly why, one fact sticks out.
Wall Street dominates the financial regulators’ process for setting disclosure requirements. Wall Street dominates the process for setting disclosure requirements because it is willing to spend much more time and money lobbying for opacity than investors are willing to spend lobbying for transparency. Wall Street is willing to spend the time and money because the benefits from opacity are concentrated in a few firms while the harm from opacity is spread across many investors.
The SohnX San Francisco Investment Conference is in the bag, and it brought a long list of investment ideas to investors. For those who didn't have a chance to catch the conference, we're outlining the long thesis for Zillow presented by SoMa's Gil Simon. Q3 2021 hedge fund letters, conferences and more Busy Years For Read More
In the second article in this series, Asset Managers as a Barrier to Transparency, I explained why asset managers are willing to invest in opaque securities where the buying and selling of these securities is nothing more than blindly gambling. Asset managers assume investors want exposure to these securities and understand the asset managers are blindly gambling with the investors’ money. Of course, this isn’t true as the asset managers are hired for their expertise. Furthermore, the asset managers aren’t going to demand more disclosure as doing so points out they are blindly gambling and puts their high paying jobs at risk.
So if the regulators aren’t up to the task and asset managers aren’t going to demand the transparency of a clear plastic bag, how can investors get the disclosure they need so they can know what they own or are thinking of buying? This is where the Transparency Label InitiativeTM comes in.
The Initiative uses a label to divide the global financial system between transparent and opaque. Where there is a label there is adequate disclosure so an investor can know what they own or are thinking of buying. Where there is not a label there is insufficient disclosure and investors are effectively blindly gambling in a rigged market.
By concentrating their investments where there is transparency, investors effectively force the issuers to disclose all the information necessary to know what they own. Why are issuers forced to disclose? It is the only way they can access the cheaper, more abundant source of funds made available by investors. Otherwise, the issuers have to compete with other issuers of opaque securities for the more expensive, limited amount of capital held for blindly gambling.
But what about the asset managers who invest in opaque securities? In the same way investors should concentrate their investments in securities having the Initiative’s label, they should concentrate their money with asset managers who are restricted to only investing in securities with the Initiative’s label.
How does a security get a label from the Initiative? There are three main steps in the process for determining if a label is merited:
- Independently determining what information is needed and when is it needed to know what you own or are thinking of buying;
- Understanding what information is currently being made available and when;
- Comparing what is needed and when it is needed to know what you own with the actual disclosure provided.
If the information disclosed and the frequency of disclosure meets or exceeds the requirements to know what you own determined in Step 1, a Label is awarded. If not, no label is awarded.
To independently determine what information is needed and when is it needed, the Initiative blends its own in-house expertise with input it solicits from buy-side participants including investors and independent third party valuation experts.
As issuers and different types of securities or global financial benchmarks and commodity prices are reviewed, the results will be published at www.instituteforfinancialtransparency.com.
The Initiative will not officially announce the awarding of any labels for some time. The Initiative recognizes it is not fair to issuers of securities not to give them a chance to adjust their disclosure practices so they provide the transparency necessary so investors can know what they own or are thinking of buying.
To date, the Initiative has reviewed a number of different securities issuers across the global financial system. There have been a number of findings.
- the Initiative has found that there are large areas of the financial system that currently provide transparency. An example of one of these areas is biotechnology.
- the Initiative has found that unless they change their disclosure practices, none of the largest global financial institutions (banks and investment banks) currently merit the awarding of a label.
- the Initiative has also reviewed many structured finance securities. With the exception of the mortgage-backed securities guaranteed by government-sponsored agencies, none of the structured finance securities currently merit the awarding of a label. In the absence of the explicit or implicit government guarantee, the government-sponsored agency mortgage-backed securities would also not merit the awarding of a label.
The Initiative is hopeful that before it officially announces the awarding of its labels, both the financial institutions and the structured finance security issuers will adjust their disclosure so a label will be merited.
To date, the Initiative has also reviewed many of the global financial benchmarks and commodity prices. The Initiative has found these global financial benchmarks and commodity prices also do not currently merit the awarding of a label. The Initiative is hopeful that before it officially announces the awarding of its labels, the global financial benchmarks and commodity prices will change the basis on which they are constructed so they will merit a label.
About the Author
Richard Field is the Director of the Institute for Financial Transparency, an organization focused on bringing valuation transparency to all the opaque corners of the financial system and the sponsor of the Transparency Label InitiativeTM.
Since the mid-90s, he has been a leader in defining and implementing transparency in the structured finance industry. Mr. Field designed, developed and patented a low cost information system to handle all of the complexity involved in making each structured finance security transparent. His solution uses a data warehouse to provide all market participants with easily accessible, standardized collateral level data on an observable event basis over the life of each deal.