The financial crisis that began on August 9, 2007 revealed a fundamental flaw in the design of the global financial system. The global financial system was designed in the 1930s recognizing market participants need the transparency of a clear plastic bag rather than the opacity of a brown paper bag if the invisible hand of the market is to operate properly.
(used with permission of author of Transparency Games)
The fundamental flaw was the design created the illusion investors could depend on the global financial regulators to maintain disclosure regulations so investors would always have the transparency of a clear plastic bag. As revealed by the recent financial crisis, this did not happen across large areas of the global financial system. This regulatory failure resulted in investors losing hundreds of billions on investments in opaque securities that met the disclosure requirements established by the financial regulators.
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.
Frequently, Wall Street’s dominance of this process has resulted in disclosure requirements that are inadequate for the purpose of investors being able to know what they own or are thinking of buying. A classic example of this failure to create adequate disclosure requirements is the SEC’s Regulation AB. This disclosure regulation was first adopted prior to the financial crisis and covers structured finance securities including the infamous opaque, toxic subprime mortgage-backed deals at the heart of the financial crisis. On August 27, 2014, after years of heavy lobbying from Wall Street, the SEC finalized its post-financial crisis update to these disclosure requirements. The updated disclosure requirements provide all the transparency of a brown paper bag as the SEC rejected providing the transparency of a clear plastic bag on the grounds it could not justify the cost to the issuers. As a result, under the updated disclosure requirements investors still won’t know what they own or are thinking of buying for either publicly traded or privately placed structured finance securities.
The Transparency Label InitiativeTM is the investors’ response to prevent future losses from the ongoing failure of the global financial regulators to require transparency that achieves the clear plastic bag standard not just for structured finance securities but in all the opaque corners of the global financial system. It ends the investors’ reliance on the financial regulators for ensuring transparency as investors recognize there is a better alternative to ensure this level of transparency than the status quo with its dependence on the regulators.
The Transparency Label InitiativeTM makes the investors’ view, rather than the financial regulators’ disclosure requirements, the global standard for adequate disclosure. It gives investors the final say on disclosure. This is appropriate as it is only the investors who can say either there is or there is not adequate disclosure so they can know what they own or are thinking of buying. In exchange for having this final say, investors recognize their responsibility for absorbing all losses on their investment exposures rather than being bailed out. This responsibility for losses gives the investors a strong incentive to both independently assess the information disclosed and use the result of this assessment to practice self-discipline by restricting the size of their investments to what they can afford to lose.
Equally importantly, under the Transparency Label InitiativeTM, investors take full responsibility for ensuring the transparency of a clear plastic bag across the global financial system. The TLI Label is only awarded where publicly traded securities, private placements and global financial benchmarks and commodity prices meet the following criteria:
All the useful, relevant information is made available in an appropriate, timely manner so market participants can independently assess this information and make a fully informed decision.
Where there is a label, investors know there is adequate disclosure. Where there is a label, investors can independently assess the disclosed information and know what they own or are thinking of buying.
Regardless of what the existing disclosure requirements might be, what financial regulators might claim or what a security’s rating might be, where there is no label investors know there is inadequate disclosure. Where there is no label, investors know there is inadequate information for them to truly know what they own or are thinking of buying. Investors recognize in the absence of a label they are not investing, but rather are blindly gambling.
The TLI label is not a credit rating. The TLI label is not a guarantee that an investor will not lose money buying a TLI labeled security. The TLI label is not a recommendation to buy, hold or sell any security or invest in a private placement. The TLI label is not a recommendation to enter into any arrangement based on global financial benchmarks or commodity prices. Rather, the TLI label is solely to help investors and other market participants distinguish between safe and unsafe financial products, rigged and unrigged markets and where there is adequate disclosure so they can make a fully informed decision and where they are blindly gambling.
As shown in the figure below, 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 TLI Label is awarded. If not, no label is awarded.
(used with permission from author of Transparency Games)
To independently determine what information is needed and when is it needed, the Transparency Label InitiativeTM blends its own in-house expertise with input it solicits from buy-side participants including investors and independent third party valuation experts.
At the same time as it is reviewing publicly traded securities and global benchmark financial prices, the TLI also determines transparency adequacy provided by privately placed securities or alternative asset manager investments as requested by investors.
Every year, the TLI will review every previously awarded TLI label to see if it is still merited. As time permits, the TLI will also review where a label was not awarded to see if there has been a change in disclosure practices so a label might now be merited.
As issuers and different types of securities or global financial benchmarks and commodity prices are reviewed, the results will appear here.
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.
First, the Initiative has found that there are large areas of the financial system that currently provide valuation transparency. An example of these areas is biotechnology.
Second, the Initiative has found that unless they change their disclosure practices, none of the largest financial institutions (banks and investment banks) currently merit the awarding of a label.
Third, 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.
All market participants are asked to subscribe:
- Mutual funds and other asset managers who, for example, want the right to represent to investors you don’t blindly gamble with the investors’ money as you restrict your investments to only where the label is present.
- Financial advisors who, for example, want to use the label when constructing investment portfolios. This is particularly useful when a widow asks for ‘safe’ investments. By definition, securities with a label are ‘safe’ to the extent that they offer the necessary transparency so their risk can be assessed. Buying securities without the label isn’t ‘safe’ as doing this is nothing more than blindly gambling.
- Global financial regulators who, for example, build the label into capital requirements so the capital requirements favor transparent over opaque investments. These requirements recognize investments made by regulated financial institutions that don’t carry a label are simply blindly gambling and must be funded primarily with equity.
- Regulated financial institutions who, for example, use the label to show compliance with capital requirements that include a distinction between knowing what you own and blindly gambling.
- Sovereign wealth funds, public pension funds, foundations and endowments who use the label as part of their criteria for eligible investments. By using the label, they buy securities where they can know what they own and avoid securities where they would be blindly gambling.
- Central banks who, for example, limit what securities they purchase or collateral they accept to only those assets that carry a label so they can know what they own or might be buying if the borrower defaults. After all, there is no reason for central banks to blindly gamble with taxpayer money by purchasing securities or accepting collateral without the label.
Individual investors who use the labels for their own investments are also asked to subscribe. In most cases, the Initiative offers you access to the labels for free. Our hope is, if you find the labels beneficial, you will make a donation to help support the cost involved in determining where a label is appropriate and where it is not.