Untangling exactly what happened at FTX will no doubt take a great deal of time, effort and investigation by the relevant authorities. For anyone interested in the scale of the challenge, I can only recommend a quick read of last week’s bankruptcy filing. But while we will not know in full how it happened for some time, there do appear to be some general themes that are very familiar to those who regulate and supervise conventional financial firms and financial instruments. The first are fundamental issues around how financial institutions should be organised, by which I mean their corporate structure, governance, internal controls and record keeping. Regardless of the financial service activity – be it banking, insurance, exchanges, clearing houses – regulation in the conventional financial sector imposes stringent/substantive requirements. Supervision aims to ensure that these are implemented. These requirements reflect the risks inherent in financial services – risks to the users, risks to other financial firms and risks more broadly to the financial system. Technology in and of itself does not change the need for transparency in corporate structures, governance, audit and systems and controls – for example to protect customers’ funds. In a similar vein, and to prevent conflicts of interest, regulation imposes requirements and  Page 3  constraints on the connections between a financial firm and its affiliates, while also requiring controllers to be fit and proper. In this respect, transparency in corporate structures and the relationships between them is the key foundation.
The tests also evaluate market interconnectedness, including the risk of major counterparty default. To increase public transparency, the Federal Reserve now publishes the overall results of its stress tests. This helps rebuild confidence in the strength of the financial system. The most recent round of stress tests concluded in the first quarter of this year. In my view, the results were encouraging, although not uniformly satisfying. In general, “firms participating in CCAR have more than doubled their Tier 1 common capital since 2009, an increase of $ billion of additional, high-quality capital in the U.S. financial system.”6 This impressive statistic notwithstanding, the Federal Reserve objected to capital plans from five of the 30 participating firms. Four of those five firms submitted plans that raised firm-specific, qualitative concerns. The remaining firm failed to meet a minimum quantitative requirement.7 The consequences of failing to pass a stress test can be severe. If its capital plan has been rejected, the Federal Reserve may, among other things, restrict a bank holding company from paying or increasing dividends on its common stock or increasing any repurchase of its common stock, or both.8 For example, as a result of this year’s CCAR, Citigroup was not permitted to begin a new common stock repurchase program or to increase its quarterly common stock dividend.9 As a companion to improved capital, the Federal Reserve also assesses liquidity – that is, how quickly a bank can convert its assets into cash.