Following moves by the Federal Reserve to arrange the sale of failing banks, debate has been heated over when and how aggressively the government should bail out foundering financial institutions.
SEC commissioner Hester Peirce knows where she stands. “The best thing we can do to protect the resilience of the financial system is to cultivate a very competitive capital market where people can enter easily,” she said. “And when they exit, it’s fine. We let them fail; we don’t bail them out.”
Speaking at a recent fireside chat hosted by the MIT Golub Center for Finance and Policy, Peirce acknowledged that her position might be unpopular of late. “We tend to always want to bail out to stop the immediate pain,” she said, “but sometimes you have to allow some immediate pain in order to have a system that’s more resilient.”
The U.S. is a country that relies heavily nonbank financial institutions, Peirce said — investment banks, money market funds, hedge funds, and private equity funds, for example.
“If we try to squeeze all the risk out of the system and make everything look like a bank, we will end up with worse capital markets,” she said. “It’s something that we have to think about when we’re writing rules: Are rules preventing new products and services from coming into the industry?”
One of five commissioners on the Securities and Exchange Commission, Peirce was appointed to a five-year term in January 2018. An attorney, she previously advised members of the U.S. Senate Committee on Banking, Housing, and Urban Affairs and served as counsel to former SEC Commissioner Paul Atkins.
During the talk, which was moderated by MIT Sloan accounting and finance professor Peirce shared her thoughts on climate-related disclosures, payment for order flow, and the value of economic analyses.
Here are four takeaways from their conversation.
Climate-related rulemaking could cool innovation
In March 2022, the SEC proposed a rule that would require public companies to disclose their sustainability goals and how they’re meeting them, among other requirements.
Peirce is concerned that the rule — and nonfinancial reporting requirements more broadly — could keep companies from innovating.
“With nonfinancial reporting, I’m afraid that introducing this to a very stringent degree would enforce a lack of innovation,” Peirce said. “If you tell people how to be sustainable, then you block out a lot of opportunities on how to do so.”
Peirce noted that asset managers and companies are supportive of this type of rule to some degree because it will give them better clarity. But the vast number of private entities that rate companies’ environmental, social, and governance performance muddles the picture, she said, noting that these agencies won’t shut down if the proposed rule goes into effect.
“They’re just going to ask you for more information, and they’re still going to do their ratings,” she said. “So I imagine we’re going to have standard built upon standard.”
Further complicating matters is that companies arrive at sustainability data points in many different ways. Often, such figures come from suppliers or customers rather than the company itself. Data may not be comparable, accurate, reliable, or consistent.
A broader, principles-based approach might be a better alternative, but even then, Peirce said, “the goal of trying to have extremely precise disclosures in this area is unlikely to be matched by reality.”
Regulating payment for order flow might not work
The SEC is looking into whether a controversial practice called payment for order flow — a growing source of revenue for retail brokers and wholesalers — creates a conflict of interest. A 2021 SEC report on the retail investor mania for GameStop and other so-called meme stocks suggested that some brokerages might be profiting from PFOF at the expense of their retail customers.
Yet if the SEC were to put in place new regulations around PFOF, they may not ultimately result in better outcomes for investors, Peirce said. “It’s hard really to say that retail investors will come out better at the end of the day.”
The SEC has addressed the issue in its proposed market structure regulation. One option is to expose retail orders from wholesalers to competition through a “qualified auction” open to all on a stock exchange such as the New York Stock Exchange or an alternative trading system.
“We’re not banning PFOF, but a lot of people think the effect would be that PFOF would probably go away,” Peirce said. And without PFOF, “would commissions come back, and would that be a better arrangement for investors? Would their execution quality go down?” she asked.
The rule “would be fairly dramatic” in dictating to a retail broker how to execute an order from a customer, she said.
“It’s an interventionist approach. We’re telling you that we know better than you do what the best way to execute a trade is,” Peirce said. “I tend not to favor interventionist approaches.”
Economists play an important role, but better data is needed
When asked by Golub Center Director whether the SEC’s use of economists to provide cost-benefit analyses on proposed rules was worth the effort, Peirce said it was effective — up to a point.
“Having economists in the room early when you’re making decisions about which policy you’re going to pursue makes sense,” she said.
Economic analysis helps to identify problems and determine whether a regulatory solution or nonregulatory one is most appropriate. If a rule is needed, analysis helps regulators select the best solution that produces the greatest benefits at the lowest cost.
For complicated issues like climate change disclosure rules, however, figuring out the right analytic approach is quite difficult, she said. Analyses also typically underestimate costs for companies, making them less helpful. More accurate initial data could help.
“Better data can help us do better analysis. If we can improve the rules around data production, then we might be able to do better rules around market structure. But I think we have to stay humble,” Peirce said. “This is very difficult work.”
Capital markets shouldn’t be political
Peirce earned a reputation early in her term as a champion for deregulation and minimal government intervention, and her philosophy has not changed.
“Investor protection, from my perspective, also means investor opportunity,” she said. “You can’t protect investors by saying, ‘You must all invest just in index funds.’ That wouldn’t be very American.”
A Republican, Peirce was appointed by former President Donald Trump and works as a minority member of the commission now headed by Democrat Gary Gensler. Asked about where she finds common ground with her colleagues, Peirce praised the balance and diversity of opinion at the SEC.
“Certainly, we have different philosophies; that’s absolutely true. But I think that ultimately, capital markets are not a political thing,” Peirce said. “Ultimately [they] serve the rest of the economy and make our people more prosperous and our nation stronger if they work well. And we all agree on that.”