Congrats Randal Quarles on Fed Appointment…

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Congratulations to Randy Quarles for his appointment and confirmation to serve as the Vice Chairman of the Federal Reserve Board.

CFS is thankful for Randy’s early and constant support of our organization. As an Advisory Board Member and Trustee, he has been a source of wisdom on a wide range of topics. In particular, his involvement in “Bretton Woods: The Founders and Future” was especially productive and meaningful. The inspiration and encouragement from Randy will continue to guide CFS especially as we plan to honor the 75th anniversary of the birth of the international financial system and think strategically about the future.

See “Summary and Next Steps  – Bretton Woods: The Founders and Future.”

Randy is uniquely experienced, remarkably learned, and thoughtful on virtually any monetary, regulatory, or related legal topic. Likewise, few to none are more honorable in character.

We wish him the best at the Fed.

FinCEN Director Examines Virtual Currency Regulatory Obligations

Financial Crimes Enforcement Network (“FinCEN”) Director Kenneth A. Blanco outlined agency efforts to protect financial institutions from fraud relating to new uses of financial technology, and described “how FinCEN is approaching virtual currency.”

Mr. Blanco emphasized FinCEN’s jurisdiction over virtual currency stating: “individuals and entities engaged in the business of accepting and transmitting physical currency or convertible virtual currency from one person to another or to another location are money transmitters subject to the AML/CFT requirements of the BSA and its implementing regulations.”

In remarks delivered at the 2018 Chicago-Kent Block Tech Conference, Mr. Blanco argued that innovation in financial services is a double-edged sword: it provides customers with greater access to various services but it can create opportunities for criminals. Mr. Blanco declared that FinCEN is focused on (i) expanding its understanding in the rapidly developing technological landscape, (ii) identifying risks, (iii) closing gaps and (iv) fostering smart innovation. FinCEN is also working to establish information-sharing programs such as FinCEN Exchange, related cyber defense programs and increased suspicious activity reports (“SARs”) to help the financial services sector protect itself from threats.

Mr. Blanco recounted FinCEN’s efforts as to virtual currency and initial coin offerings, including a listing of each of the major FinCEN administrative rulings as to the treatment of such products. In particular, Mr. Blanco stated that FinCEN expects businesses involved in initial coin offerings to meet all of their obligations in regard to anti-money laundering (“AML”) and combating the financing of terrorism. Mr. Blanco noted that financial institutions have been more active in the past couple of years as demonstrated by the increase in filings of virtual currency SARs.

Lofchie Comment: Not that one more cautionary warning was needed, but here is another cautionary warning that all firms involved with virtual currency or initial coin offerings must be extremely diligent in their procedures as improper activities may result in violations of not only securities and commodities laws, but also in those regarding money laundering.

Attorneys General Urge SEC to Strengthen Proposed Regulation Best Interest

A coalition of 17 Attorneys General (“AGs”) urged the SEC to bolster the requirements set out in proposed Regulation Best Interest (the “Proposed Rule”).

In a comment letter to the SEC, the AGs criticized the Proposed Rule, asserting that it (i) sets out a weak “best interest” standard that falls short of a uniform fiduciary standard and fails to require broker-dealers to act as fiduciaries for their clients; (ii) fails to sufficiently resolve broker-dealer conflicts of interest by turning a blind eye to harmful practices and erroneously relying on the “good faith of broker-dealers to fashion effective policies”; (iii) relies too heavily on disclosures, which alone are not effectual in protecting investors; and (iv) is fraught with ambiguities, leaving key terms undefined and causing confusion for regulators and investors.

The AGs recommended the following:

  • the Proposed Rule should be altered to impose a uniform fiduciary standard on broker-dealers and investment advisers;
  • the SEC should enhance certain disclosure requirements;
  • protections against conflicts of interest should be adopted; and
  • the SEC should ensure that all key terms and provisions are clearly defined.

Lofchie Comment: It is a safe bet that any time a regulatory advocate describes its recommendations as being “common sense,” they are not. According to the state attorneys general, imposing additional burdens on broker-dealers can be done “without compromising investor access to financial professionals, the availability of diverse financial products, or choice in fee arrangements.” That seems a remarkable conclusion: how can it possibly be that one can impose material additional requirements as to the provision of a service, and yet there is no effect on the availability or cost of that service? If it is so obvious that this can be accomplished as to securities transactions, then surely the NYC subway service can be similarly enhanced without any increase in cost or other ill effect.

There are certainly arguments that can be made in favor of Regulation Best Interest. A reasonable starting point should be to ask whether the regulation is worth the increased costs and the diminished availability of certain services. This requires advocates of the proposed regulation to be at least willing to concede the existence of trade-offs, and (even better) to attempt to quantify them to the extent possible. If there are no trade-offs, and if everything is free, a subway train should have already arrived at the station.

International Regulators Launch “Global Financial Innovation Network”

Several international regulatory agencies collaborated in the creation of the “Global Financial Innovation Network” (“GFIN”). The new network will focus on regulatory issues related to emerging technologies. There are 11 regulatory agencies in the new network including the Consumer Financial Protection Bureau and the UK’s Financial Conduct Authority.

In a draft consultation document, the agencies explained three major functions of the initiative: (i) information- and knowledge-sharing among regulators, (ii) collaboration in exploring major policy questions and (iii) “cross-border trials” instituted to aid companies as they deal with multi-jurisdictional regulatory challenges. The network is intended to serve as a resource for FinTech companies navigating the complicated web of international regulation. The regulators anticipate that GFIN will increase the speed at which innovative products are able to reach international markets. They also argue that the GFIN will promote transparency and investor protection.

The GFIN proposed the following as its organizational mission statement:

“The GFIN is a collaborative policy and knowledge-sharing initiative aimed at advancing areas including financial integrity, consumer wellbeing and protection, financial inclusion, competition and financial stability through innovation in financial services, by sharing experiences, working jointly on emerging policy issues and facilitating responsible cross-border experimentation of new ideas.”

The GFIN is requesting feedback on its proposed objectives, functions and structure. Comments must be submitted by October 14, 2018.

President Trump Imposes Sanctions against Iran

The Trump administration issued a new Executive Order (the “New Iran E.O.”) imposing certain U.S. sanctions against Iran, effective August 7, 2018.

Consistent with President Trump’s May 8 announcement ending U.S. participation in the Joint Comprehensive Plan of Action (Iran nuclear deal), the New Iran E.O. restores sanctions related to, among other things: (i) the Iranian government’s purchase or acquisition of U.S. dollars; (ii) Iran’s trade in gold and precious metals; (iii) the sale, supply or transfer to or from Iran of graphite, raw or semi-finished metals, and software for integrating industrial processes; (iv) significant transactions related to Iran’s national currency, the rial, and the maintenance of significant funds or accounts outside the territory of Iran denominated in the Iranian rial; (v) the purchase, subscription to, or facilitation of the issuance of Iranian sovereign debt; and (vi) Iran’s automotive sector.

In addition, certain wind-down authorizations expired at 11:59 p.m., EDT, on August 6, 2018, namely, those related to (i) the importation into the United States of Iranian-origin carpets and foodstuffs; (ii) activities related to the export or reexport to Iran of commercial passenger aircraft and related parts and services; and (iii) activities undertaken pursuant to General License I that relating to contingent contracts for activities related to passenger aircraft-related licensing.

In connection with the above, the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”) issued FAQs regarding the New Iran E.O., and updated certain existing Iran sanctions-related FAQs.

 

CFTC Chair Evaluates Challenges Facing Derivatives Market

CFTC Chair J. Christopher Giancarlo assessed the challenges facing the CFTC and the United States in the global competition as a center for the derivatives markets. In an address at the West Texas Legislative Summit, Mr. Giancarlo warned that the CFTC must be proactive if the United States is to retain its preeminent position in the global financial markets.

Mr. Giancarlo described the significance of the commodity derivatives market and its impact on pricing. He pointed out that even those who do not participate in such markets are still affected and that 90 percent of companies in the Fortune 500 use derivatives to hedge. He highlighted the challenge of global competition, particularly China’s domestic futures market, specifically alluding to the country’s recent opening to international participation, which has “competitive implications” for the United States. To maintain “world leadership,” he said, it is urgent that derivatives markets in the United States maintain “openness, orderliness, and liquidity” to sustain global economic leadership.

Mr. Giancarlo emphasized the importance of establishing a regulatory framework that is “ahead of the curve,” and advocated for the “SMART-REG” approach he first outlined in 2014. This approach, he said, is intended to “solve problems – real problems, not invented ones.”

Mr. Giancarlo asserted that under his leadership, the CFTC has “emphasized greater care and precision in rule drafting, more thorough econometric analysis, and a reduced docket of new rules and regulations to be absorbed by market participants.”

Lofchie Comment: Chairman Giancarlo went beyond a discussion of the derivatives markets to discuss the underlying commodities markets. In explaining the success of the shale revolution in the United States, he described a “combination of American technological innovation, North American geology, U.S. property law, the skilled and entrepreneurial American workforce and our dynamic capitalist economy.” Chairman Giancarlo continues to be a voice of clarity and an educator in an often confused debate about the value of markets and the limits of governments as providers of services and products.

It is not so long ago that the Union of Soviet Socialist Republics collapsed in economic failure. That collapse seemed as if it would put an end to any debate as to the benefits of government ownership of the means of production. But today that debate is revived, or at least there are new advocates for it. To the extent that these advocates are taken seriously, it is important that advocates for private enterprise and for market competition not be shy to point out successes, face criticisms and to make comparisons as to the successes of different systems.

UK-US Financial Regulation: The Benefits of Greater Coherence

“UK-US Financial Regulation: The Benefits of Greater Coherence” illustrates the importance of “regulatory coherence” across borders.

Authors Ike Brannon, Bob Jennings, and Julie Chon delve into the longstanding and seminal UK and US relationship from a financial regulatory perspective.  They examine pathways to deepen and formalize cooperation with the aim to strengthen the international financial system.

As always, comments, critique, complement, or alternative thoughts are eagerly sought.

View the paper.
http://www.centerforfinancialstability.org/research/US_UK_Regulatory_Coherence.pdf

Fed Balance Sheet Since 1914

Kurt Schuler (CFS senior fellow in financial history) and students of Steve Hanke (CFS special counselor) converted the Fed’s weekly balance sheet from its beginning into spreadsheet form.

The data should prove useful for anyone concerned with the quantitative study of monetary policy in the United States over the last 100+ years.

Our joint Johns Hopkins / CFS working paper, “The Federal Reserve System’s Weekly Balance Sheet since 1914,” is available here.

Accompanying Spreadsheets

Similarly, Bank of England’s Ryland Thomas informs of an improved balance sheet dataset for the Bank and new paper “The Bank of England as lender of last resort: new historical evidence from daily transactional data.”

SEC Rejects Proposal to List Bitcoin-Based ETP on Regulated Exchange

By a three-to-one vote, the SEC rejected a second application by the Bats BZX Exchange (“BZX”) (now owned by Cboe Global Markets) to list a bitcoin-backed exchange-traded product (“ETP”). The proposal, which was previously rejected by the SEC Division of Trading and Markets, would have permitted the listing and trading of shares of the “Winklevoss Bitcoin Trust.” The ETP would have (i) held only bitcoins as an asset and (ii) tracked the price of bitcoin on the Gemini Exchange, a cryptocurrency exchange founded by Cameron and Tyler Winklevoss. To date, the SEC has not approved a cryptocurrency-backed ETP.

Exchange Act Section 6(b)(5) requires that the rules of a national securities exchange be designed to (i) “prevent fraudulent and manipulative acts and practices” and “protect investors and the public interest.” In its Order, the SEC asserted that the price of bitcoin can be (and has been) manipulated through activity on bitcoin trading venues. The SEC rejected the claim by BZX that it could monitor the Gemini Exchange for potential price manipulation, finding that the Gemini Exchange did not materially represent the bitcoin market. The SEC pointed to BZX’s lack of surveillance-sharing agreements with significant, regulated markets as inconsistent with SEC-approved commodity-trust ETPs. The SEC further rejected the argument that bitcoin spot markets are inherently resistant to manipulation due to the decentralized nature of blockchain technology. In sum, the SEC found that BZX failed to establish that its various surveillance proposals were sufficient to protect investors from fraud as required to comply with Exchange Act Section 6(b)(5).

Commissioner Hester Peirce dissented from the SEC order and argued that the BZX proposal met the Exchange Act Section 6(b)(5) standard. Ms. Peirce contended that her fellow Commissioners focused too heavily on the shortcomings of the underlying bitcoin spot market, and failed to give proper consideration to BZX’s surveillance and fraud detection capabilities. She asserted that many commodity-based ETPs would be in danger if the Order’s standard for bitcoin were universally applied. Further, Ms. Peirce stated that the outcome undermined investor protection and represented a missed opportunity to institutionalize and legitimize the bitcoin market.

GAO Calls for Urgent Action to Address Nationwide Cybersecurity Challenges

In a study conducted to update its identification of information security risk areas, the Government Accountability Office (“GAO”) identified four primary cybersecurity challenges and ten corresponding actions that the federal government and other entities must undertake to address them.

The four challenges are (i) establishing a comprehensive cybersecurity strategy and performing effective oversight, (ii) strengthening federal systems and information, (iii) safeguarding cyber critical infrastructure, and (iv) protecting privacy and sensitive data.

The four actions needed to address the first challenge are:

  • developing a more exhaustive federal strategy for national cybersecurity;
  • mitigating global supply chain risks;
  • addressing cybersecurity workforce management challenges (since the federal government faces challenges with respect to ensuring that the nation’s cybersecurity workforce has the necessary skills); and
  • ensuring the security of emerging technologies (such as artificial intelligence and the Internet of Things).

The three actions outlined to deal with the second challenge are:

  • improving the implementation of government-wide cybersecurity initiatives;
  • addressing weaknesses in federal agency information security programs; and
  • bolstering the federal response to cyber incidents.

To confront the third challenge, the GAO identified the need for a more robust federal role in protecting the cybersecurity of critical infrastructure (such as electricity grids and telecommunications networks).

With regard to tackling the fourth challenge, the GAO called for improving federal efforts to protect privacy and sensitive data, limiting the collection and use of personal information, and ensuring that personal information is obtained with appropriate knowledge or consent.

Since 2010, the GAO has made over 3,000 recommendations to federal agencies that relate to mitigating cybersecurity weaknesses. As of July 2018, approximately 1,000 recommendations still need to be implemented.

U.S. Agencies Warn Businesses of North Korean Sanctions Evasion Tactics

In an advisory titled: Risks for Businesses with Supply Chain Links to North Korea, the U.S. State Department, the U.S. Treasury Department Office of Foreign Assets Control, and the U.S. Department of Homeland Security Customs and Border Protection and Immigration and Customs Enforcement (the “agencies”) warned of tactics used by North Korea to evade sanctions.

The agencies warned businesses that falling for attempts by North Korea to evade U.S. and UN trade and labor sanctions could subject those businesses to legal liability. The agencies emphasized two primary areas of risk for businesses: (i) unintentionally sourcing services, goods or technology from North Korea and (ii) having North Korean citizens or nationals, whose labor produces revenue for the North Korean government, in a company’s supply chains.

The agencies urged businesses to implement necessary due diligence best practices, and to review their supply chains for North Korean laborers, goods and services.