Bretton Woods on the Radio

Sunday, December 16 from about 9:45 to 10 p.m. Eastern Standard Time I will be on the John Batchelor radio show with guest host Chris Riback to talk about The Bretton Woods Transcripts. The show originates from WABC in New York, 770 on the AM dial. The station’s signal reaches across much of the eastern United States. You can also listen to the broadcast live online (click the “listen live” button near the top right of the page), or later on the  podcast page for John Batchelor.

CFTC Commissioners Chilton and Sommers on Dodd Frank Implementation

CFTC Commissioners Bart Chilton and Jill E. Sommers (Chair of the Global Markets Advisory Committee) delivered testimony on the status of Dodd-Frank before the U.S. House of Representatives Committee on Agriculture Subcommittee. 

Commissioner  Sommers shared her view on the challenges facing regulators across the globe in trying to meet the commitments on over-the-counter (OTC) derivatives reform made by G20 Leaders in 2009 as well as the challenges presented in interpreting the cross-border scope of Dodd-Frank. In particular, Sommers highlighted five areas which need further exploration, according to several regulatory leaders across the globe. These areas are:

  • the need to consult with each other prior to final determinations regarding which products will be subject to a mandatory clearing requirement and to consider whether the same products should be subject to the same requirements in each jurisdiction;
  • robust supervisory and cooperative enforcement arrangements to facilitate effective supervision and oversight of cross-border market participants, using IOSCO standards as a guide;
  • reasonable, time-limited transition periods for entities in jurisdictions implementing comparable regulatory regimes that have not yet been finalized and clear requirements on cross-border applicability of regulations;
  • preveningt the application of conflicting rules and minimize the application of inconsistent/duplicative rules; and
  • continued development of international standards by IOSCO and other standard setting bodies.

Commissioner Chilton testified that there were some flaws in the manner that the CFTC had handled the October 12 “deadline,” which had resulted in the CFTC issuing numerous no-action letters at the last minute (or later in some cases).  In this regard, Commissioner Chilton stated:

“We do not want to repeat the process we–and the markets–underwent in October. In that instance, market participants were unclear what things would truly be required on the October 12th compliance date. We ended up working it all out, but it should have, and could have, been done in a more open and streamlined fashion. We need to avoid that now as we approach January 1, 2013 implementation of certain rules and regulations. This would give markets and participants time to comply with the new regulatory environment and also would provide assurance to global markets and regulators that we are not causing unnecessary market disruptions.”

Commissioner Chilton stated, as to the CFTC’s ability to issue no-action letters so as to avoid deadlines, “And we’ve shown that we can be flexible in implementation content and timing. The result is that during these delays, the rest of the world, and particularly the European Union, has caught up to us. It now appears that E.U. regulations will be implemented in a matter of months after U.S. rules may be finalized, as opposed to the two years originally envisioned.”

To avoid a repeat of the October disruption at the end of December, Commissioner Chilton made the following recommendations for further delay and for limiting the scope of U.S. rules:

  • extend the narrower, territorial definition of U.S. Person used in the CFTC’s October 2012 staff no-action letter;  [see link to this below]
  • U.S. and foreign SD/MSP registrants would have interim relief from compliance with external business conduct standards, and during the interim period, should operate under a “good faith” compliance standard;
  • allow non-U.S. dealers to not register when facing registered U.S. swaps dealers;
  • provide relief as to the swaps dealing aggregation standard.

Lofchie Comment:  Sometimes, maybe quite a lot of the time, I just struggle to find the right tone for these comments.  As to the regulatory process, perhaps all one can say is “Really?”  While I have never been myself a regulator, I do have experience with raising goldfish in my sink.  From this experience, I know that if I set unclear or inconsistent rules for the goldfish, subject to impossible deadlines, and then I suspend those rules at the last minute, the goldfish lose respect for the process.  In extreme cases, they cease to swim in circles on their bellies and start swimming in straight lines on their backs. 

So let’s turn to what should be done.

First off, once a member of the majority party of the CFTC anounces that there has to be a six-month delay in rule implementation, it is incumbent to follow through quickly on an official announcement of this delay.  Certainly, the market expects it to be announced. 

Even leaving aside the implied promise (or suggestion) that there will be a delay, it is my general sense that there are numerous respects in which neither financial nor commercial entities are ready to go “live” with Dodd-Frank on December 31st.  Further, many of those not ready to go live also have to do their Christmas shopping, recover from Sandy and watch the Patriots/Niners game, making it bascially  impossible to be done by the “deadline”-even if we actually knew what rules were going to go live on that date, which we don’t.  On top of this, there is the problem that firms generally stop revising their internal IT near the end of the year, which means that the further threat of all these last minute changes creates a great risk of computer glitches (the regulators ought to be bear in mind everything that went wrong with technology this year).  On top of that more, there is an expectation that there will be a ongoing flow of no-action letters providing for “time-limited” and narrow relief, which means that no one can be certain which of the impossible deadlines they should focus on achieving.  Against this background, I simply am not sure what “good faith” means?  If firms don’t cancel everyone’s Christmas vacations so as to implement Dodd-Frank compliance processes, are they in good faith?

My suggestion is that the CFTC Commissioners should commend their staff for a heroic job of attempting to implement Dodd-Frank faster than any other regulator in the United States or elsewhere in the world.  In spite of this great attempt, it has simply become clear that to everyone that one relatively small domestic regulator adopting and going effective with  swap rules piecemeal just did not work in the context of an immense global financial system.  Accordingly, the CFTC should determine to coordinate with the SEC and to follow the same approach that the SEC is following: to present the U.S. public (and the rest of the world) with one complete set of rules that can be understood, and commented upon, as a whole.

As to the delay that this may cause, I note that Commissioner Chilton indicates that the United States is only a few months ahead of the rest of the world in adopting a scheme of swaps regulation.  Well, then, let’s take a holiday break and let the rest of the world catch up.  Otherwise, my prediction is that U.S. firms are going to be operating at a very significant disadvantage in global competition, with all the damage that will do to the U.S. economy. 

I am also going to comment on one of Commissioner Chilton’s specific proposals:  non-U.S. swaps dealers should not be required to register as a result of the business that they do with U.S. registered swap dealers.  YES!!  This is such an obvious necessity that it is hard for me to believe that it is coming up this late in the game.  Unless one wants to put a significant crimp in global commerce, there has to be a way for global financial institutions to do business with each other across national lines without all of them registering with the CFTC.   

View Sommers’ speech; Chilton’s speech (links externally to CFTC website).
See also:  News Item Regarding CFTC October No-Action Letter as to Definition of US persons (I note that the dissatisfaction with regulatory process that I expressed in the October comment to that news item still seems accurate, even if one wishes it were outdated).

CFTC Chairman Gary Gensler Says CFTC Aims to Finalize Swaps Rules by Mid-2013

In a testimony before the U.S. House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises, Chairman Gensler gave a speech on the New Era of Swaps Market Reform.  He generally repeated statements, or portions of statements, that he had made in the past.

Lofchie Comment:   One part of the speech that I thought an interesting development were Chairman Gensler’s statements as to the regulation of non-U.S. entities.  He said, “For firms that do register with the CFTC, we are very committed to allowing for substituted compliance, or permitting market participants to comply with Dodd-Frank through complying with comparable and comprehensive foreign regulatory requirements.”  This would suggest that the CFTC is abandoning its initially stated policy of looking rule-by-rule at the regulatory regimes of other countries to determine whether substituted compliance should be permitted as to any firm, and is moving towards a policy of permitted very broad substituted compliance.  As we had previously stated, this is a welcome reassessment given the very adamant opposition of non-U.S. regulators to the CFTC’s initial policies. 

That said, if broad substituted compliance is permitted, the question for U.S. firms is whether the regulatory requirements to which they are subject are so burdensome by comparison to non-U.S. firms that their competitive position is materially eroded.

Click here to view testimony in full (links externally to CFTC website).

SEC Director Cook’s Speech on Title VII Implementation

SEC Director, Division of Trading and Markets, Robert Cook delivered a speech before the Capital Markets and Government Sponsored Enterprises Subcommittee of the Committee on Financial Services on the ongoing implementation of Dodd-Frank Title VII, and the Commission’s efforts to address the application of the security-based swap provisions of Title VII in the cross-border context.  See below for topics included in his speech:

  • Ongoing regulatory coordination with the CFTC and other regulators;
  • Adoption of key definitional rules;
  • Adoption of rules related to clearing infrastructure;
  • Proposal of capital, margin and segregation requirements;
  • Issuance of implementation policy statement;
  • Application of Title VII in the cross-border context; and
  • Additional steps.

Lofchie Comment:  Given that we are publishing speeches by two regulators on the same day on the same topic, it would be very difficult not to compare them.  So I am going to do the easy thing.  (Life is hard enough.) The speech by CFTC Chairman Gensler takes as its point of emphasis the percentage of rules completed by the CFTC, the number of no-action letters issued to clarify those rules, and like quantitative matters.  On the other hand, the speech by Director Cook emphasizes the challenges of co-ordination with numerous domestic and international regulators and the need to develop a transparent implementation schedule.  To a good extent, these speeches seem to reflect the very different approaches taken to Dodd-Frank implementation by the two regulators.  Its like Venus and Mars.

View testimony in full here (links externally to SEC website).

Financial Services Committee Chairman Bachus on Economic Impact of Derivatives Regulations

Financial Services Committee Chairman Spencer Bachus released a statement at a subcommittee hearing on the economic impact of derivatives regulations contained in Title VII of the Dodd-Frank Act.  The closing line of the statement was: “The 113th Congress will have the opportunity to examine if the rules promulgated by the SEC and CFTC can actually work once they are operational or if we will witness regulatory chaos and a flight of capital from the U.S.”

Lofchie Comment:  One point that Chairman Bachus makes that I think important is that Dodd-Frank will have real economic consequences.  Proponents of the statute hope those consequences will be positive; critics fear that those consequences will be negative.  But at least some of the consequences should be measurable:  volume of business, pricing, transaction costs, number of market participants and (I am sure) other data points.  It would be a good thing if the government would make available to the public as many of those measurables as possible so that there can be as much assessment of the consequences as possible.  If the consequences turn out to be materially positive, then certainly Congress should take as its goal that the next bit of financial regulation is twice as long; if the consequences are negative, perhaps we can erase some of what we have.  But without some attempt to assess things that can be measures, we will all just keeping talk past each other.

View statement in full here (links externally to Financial Services website).

SEC Grants No-Action Relief with Respect to Classification of Certain Persons as Owners of Broker-Dealers for Purposes of the Capital Rule

The SEC granted no-action relief to FINRA’s Vice President, Risk Oversight & Operational Regulation, Kris Dailey under the condition that if a broker-dealer were to classify a person in one or more classes of ownership of the broker-dealer as an owner of the firm (and not a customer) for purposes of Rule 15c3-3, and such person’s contributions in the firm as equity capital for purposes of Rule 15c3-1, as set forth below:

  1. The Broker-Dealer obtains an opinion of independent legal counsel that (a) it is duly formed, validly existing, and in good standing; and (b) its governing documents, such as its Articles of Formation, By-Laws, Operating Agreement or Partnership Agreement as the case may be, are enforceable in accordance with their terms, each in the jurisdiction in which the Broker-Dealer was formed, organized or incorporated.
  2. Upon request by the SEC or FINRA, the Broker-Dealer must be able to establish that the person is an equity participant in the firm under applicable law in the jurisdiction in which the Broker-Dealer was formed, organized or incorporated.
  3. The relationship between the person and the Broker-Dealer, and all applicable conditions of the arrangement, must be documented in an executed writing wherein the parties agree and acknowledge certain conditions (see letter for more details).
  4. The person annually thereafter re-affirms in writing his/her understanding of, and agreement with, the terms and conditions of the executed agreement as referenced in Item 3 above.
  5. The Broker-Dealer ensures that the person is appropriately registered with its designated examining authority for any activity performed by the person for which registration is required. If the person is not a natural person, each person authorized to perform any activity for which registration is required on behalf of that person must be so registered. Further, the Broker-Dealer has implemented a system of supervisory compliance and controls that applies to such activities of the person and all others authorized to perform such activities on behalf of that person.

Lofchie Comment:  This letter deals with the situation where a firm’s “employees”/”owners” are effectively customers of the firm trading their own capital through the firm.  The legal status of such arrangements has always been subject to various uncertainties, including as to the capital treatment of the owners’ investments, given that the owners would expect to be able to withdraw their equity when they leave the firm.  This letter provides guidance that these arrangements are permissible, at least insofar as the money invested by individual owners may be treated as equity capital, provided, among other things, that (i) the money stays in the firm for at least one year and (ii) the investment is at risk if the firm as a whole were to fail.  Although the letter requires that the money stay in the firm for one year, once that period has passed, the letter does not require a specified period between an owner’s notice of the desire to withdraw capital and the withdrawal (although the withdrawal could not throw a firm into capital deficiency).

View Letter in full here (links externally to SEC website).

European Parliament Approves Enhanced Cooperation Agreement on Financial Transaction Tax

The European Parliament approved its recommendation allowing for 11 EU Member States to proceed with an Enhanced Cooperation Agreement (ECA) on a Financial Transaction Tax (FTT).  The approval now allows the European Union Member States in the Council of the European Union to officially proceed in seeking an ECA on a financial transaction tax plan. MEPs have long advocated an FTT to make financial market players take more responsibility for resolving the crisis that they caused and to discourage excessive risk-taking in the future.

According to the press release, “It is not a solution to spare the financial sector from a tax, the very same sector which is now even benefiting from the crisis.”  The text stresses that the ultimate goal should still be a worldwide FTT, and urges the EU to continue campaigning for it. The 11 participating countries are Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain.

 

Click here to view press release in full (links externally to European Parliament/News website).

In Ten Years It Will Be Free

The Internet has created new possibilities for distributing previously out-of-print writings. At the same time, the United States and many other countries have greatly extended the length of copyright. The result is that writings that are valuable for the advancement of knowledge but that have very small readership are copyrighted for decades longer than was envisioned when they were written. Some works that were out of copyright have even gone back into copyright. Publishers have made some works accessible behind pay walls, but others remain unavailable in any legal digitized form.

To prevent such a fate from ever befalling The Bretton Woods Transcripts, Andrew Rosenberg and I have voluntarily limited our claim of copyright to the electronic version of the book to ten years. Starting in 2023, anybody will be able to reproduce the electronic version provided that he distributes it to readers for free. Few scholarly books will ever be big sellers, especially a decade after their first publication. We recommend voluntary, binding limitation of copyright claims as a way for other scholars to balance the benefits of whatever royalties their work might generate against the benefits of having the work readily available, clear of any legal entanglements from copyright.

(Andrew and I will retain other rights not important for scholarship, including the movie rights. Steven Spielberg, call us. We have in mind Daniel Day-Lewis to portray John Maynard Keynes, with Steve Buscemi as Harry Dexter White.)

SEC to Resume Exemptive Orders for ETFs Using Derivatives

The SEC Division of Investment Management announced that it will no longer defer consideration of exemptive requests under the Investment Company Act relating to actively-managed ETFs that make use of derivatives, provided that the ETFs include representations to address some of the concerns expressed in the March 2010 press release.  These representations are as follows:

(i) that the ETF’s board periodically will review and approve the ETF’s use of derivatives and how the ETF’s investment adviser assesses and manages risk with respect to the ETF’s use of derivatives; and
(ii) that the ETF’s disclosure of its use of derivatives in its offering documents and periodic reports is consistent with relevant Commission and staff guidance.

The Staff further stated that it would not recommend enforcement under Investment Company Act Sections 2(a)(32) (redeemable security), 5(a)(1) (subclassification of management companies), 17(a) (transactions of certain affiliated persons and underwriters), 22(d) and 22(e) (distribution, redemption, and repurchase of securities; and regulations by securities associations), or Rule 22c-1 thereunder, given certain conditions provided in the letter. This position is provided for enforcement purposes only, and applies to those actively-managed ETFs listed on Attachment A of the letter.

Lofchie Comment:   This impending change in practice was previously announced by Norm Champ, the Director of Investment Management.  (SEC Director Champ Remarks on Investment Adviser Regulation)

Click here to view letter in full (links externally to SEC website).

Jennifer McHugh Named Senior Advisor in SEC’s Division of Investment Management

The SEC announced that Jennifer B. McHugh has been named Senior Advisor to the Director in its Division of Investment Management.  Beginning December 17, McHugh will be advising the Director of Investment Management on issues related to mutual funds and investment advisers.

Click here to view press release (links externally to SEC website).