Federal banking agencies are fiercely waging what some big banks consider a jihad mandating tough new rules. Some of the rules are warranted, some not. Regardless, what’s completely missing and all too essential is action on all the other manifest threats that aren’t big banks.
Indeed, one looming nonbank’s systemic merger poses a clear and present danger: Intercontinental Exchange Inc. (ICE). ICE, an already-systemic global clearing and settlement powerhouse, is now poised to gain still greater control over critical portals across the even more systemic $12 trillion mortgage market through a merger with real estate software company Black Knight.
So much could go so wrong so fast if ICE is allowed to complete its acquisition of Black Knight that, should this occur, the firm as a whole must quickly be designated a systemic financial market utility and regulated as such by the Federal Reserve.
As already stipulated in U.S. law and rule, financial market utilities are entities that control systemic payment, settlement, clearing or exchange functions as determined by the Financial Stability Oversight Council (FSOC). Trillions of dollars silently flow through these entities every day. Financial market utilities are like plumbing: We take them for granted, but miss them — sometimes grievously — the minute something stops flowing, backs up, or worse, floods. When this happens in the trillions of dollars in payment, settlement, clearing or exchange transactions every hour of every business day, risk moves in an instant from the personal to the institutional to the systemic to the macroeconomic.
Why is ICE a financial market utility and how does its risk grow still more insuperable if it acquires Black Knight and still stands immune from enterprise-wide safety and soundness regulation?
Regulators have acknowledged ICE’s existing systemic scale in two relatively small corners of its global empire. In 2012, the U.S. FSOC designated ICE Clear Credit LLC as a financial market utility because this venture is a central counterparty that clears the majority of U.S. credit default swaps, derivatives that permit financial institutions and even speculators to hedge credit risk or bet big on it. This is clearly a systemic arena — the total gross notional value of outstanding credit default swaps is $10.9 trillion.
ICE is also a major financial market presence outside its credit default swaps clearing activities, controlling as it does the New York Stock Exchange and numerous other equity, foreign exchange, commodity and bond market platforms around the world. Its scale outside the U.S. is formidable — for example, the United Kingdom has designated ICE Clear Europe. ICE is indeed so important in so many markets that its concerns about implementing the Russian oil price cap set by G-7 heads of state have threatened its implementation in the European Union.
Combining ICE’s global reach across core markets with a dominant role in U.S. mortgage finance would also heighten the risk that even a minor operational problem would snarl critical markets. Earlier this year, the NYSE suddenly stopped working. When it came back, investors were out millions of dollars, but ICE essentially told them to take it like grown-ups until the SEC strongly suggested otherwise.
Is this all the risk ICE poses? Absolutely not. As I have demonstrated in a longer paper, ICE’s control of key financial and mortgage market infrastructure creates clear systemic risk transmission channels using the standards by which global and U.S. regulators measure and control it.
First and foremost is the fact that even a short-term operational hiccup at ICE/Black Knight could shake financial stability because remaining large-scale alternative suppliers of critical market infrastructure will fade away under ICE’s withering market power.
This risk is already on the rise due to the rapid adoption of “deep learning” versions of artificial intelligence in key trading and credit underwriting markets. ICE is among the players deploying AI, but it is outside the reach of regulatory efforts to prevent discrimination or the highly correlated risks resulting from opaque models driving risk decisions across the capital and/or mortgage markets. ICE even plans on linking them once it acquires Black Knight by, for example, establishing new futures and secondary markets for mortgages.
ICE/Black Knight would also operate outside the reach of stability-critical operational and resolution rules. The NYSE outage noted above is clear evidence that even a small failure is highly disruptive in the absence of alternative systems or obligations to quickly make things right.
What if an ICE/Black Knight outage in the credit default swaps, foreign exchange, commodity, mortgage or another market adversely affected one or both of the huge government-sponsored enterprises whose own temporary outage in 2008 forced hundreds of billions in taxpayer bailout? Systemic banks and financial market utilities are required to have contingency plans ensuring ongoing service under even acute stress. ICE must be required to do the same across the full scope and scale of its operations, not just in its central counterparty corners.
Regulated banks and financial market utilities are also required to ensure that solvency, liquidity or operational stress do not create a systemic failure leaving gaping holes in global financial markets only taxpayers can fill. Been there, done that and ICE should not be allowed to pose risks known all too well to systemic regulators, not to mention taxpayers.
We know none of these risks is theoretical because entities such as ICE have in the past failed with such catastrophic effects. Although the extent to which nonbank financial companies should be systemically designated is controversial, neither the Trump nor Biden administration has done anything but reaffirm the importance of the 2011 financial market utility designation framework. It hasn’t been used since ICE’s central counterparty and other firms were designated as financial market utilities in 2012.
Much has happened since then in terms of concentrated market power, the growing use of AI, the increasing digitalization of critical infrastructure services and the risks of cybersecurity, geopolitical and even climate-induced financial crises.
Any firm as dominant and powerful as the combination of ICE and Black Knight warrants rapid mobilization of a systemic risk designation to demand effective governance, resilience, transparency and resolvability before yet another financial crisis teaches us the cost of infrastructure failures all over again.
Karen Petrou is the managing partner of Federal Financial Analytics, Inc. and the author of “Engine of Inequality: The Fed and the Future of Wealth in America.”