CFTC Chairman Gensler Testifies on Implementation of Dodd-Frank and Its Jurisdictional Reach

CFTC Chairman Gary Gensler testified before the Senate Committee on Agriculture, Nutrition & Forestry, and addressed the CFTC’s regulation of the swaps and futures markets.  According to Chairman Gensler, “the public is benefiting.” Chairman Gensler indicated that the CFTC had adopted 80% of its required rules, though he did not discuss how many had come into force.  He said, “As it is sometimes the case with human nature, the agency receives many inquiries as compliance deadlines approach.” 

Chairman Gensler did not indicate in his speech that there were any material problems implementing what he described as the “common sense rules of the road,” although he did say that some swaps dealers may be moving trades offshore to avoid the application of Dodd-Frank. 

On the question of whether hedge funds would (eventually) be treated as U.S. persons under Dodd-Frank (currently a non-U.S. organized fund would not be treated as a U.S. person), Chairman Gensler said, “collective investment vehicles, including hedge funds, that either are managed (or otherwise have their principal place of business) in the United States, or are directly or indirectly majority owned by U.S. persons [should not be able] to avoid the clearing requirement – or any other Dodd-Frank requirement – simply due to how they might be organized.”

As to the issue of the CFTC’s reauthorization and budget for next year (noted in the next news item), Chairman Gensler said, “The CFTC is currently funded at $207 million. To fulfill our mission for the benefit of the public, the President requested $308 million for fiscal year 2013 and 1,015 full-time employees.”

Lofchie Comment:  Although Chairman Gensler did not indicate there were many ongoing problems with the implementation of Dodd-Frank, he did touch at least indirectly upon one problem that I think is material:  neither dealers nor customers want to do swaps business in the United States.  Although I am sure that the United States will be able to force some parties to keep their swaps business here, in the long run, it is likely to prove a difficult task to keep the financial industry here by mandate.

On the issue of a mandate, swaps markets participants should note that Chairman Gensler suggested a significant expansion of the application of the “U.S. person” definition to hedge funds beyond that which is set forth in the CFTC’s most recent guidance on the subject, and he suggested that the CFTC would seek to force those funds that fell within an expanded definition of “U.S. person” to keep their business in the United States.

Query:  if the United States forces swaps “U.S.” customers to do business in the United States, does that mean other countries will respond by requiring their local customers to do business only in their home countries or regions?  If so, is that a good result for the U.S. economy?

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

Senate Committee on Agriculture, Nutrition and Forestry Chairwoman Stabenow Announces Plans for CFTC Reauthorization

Chairwoman of the U.S. Senate Committee on Agriculture, Nutrition and Forestry, Senator Debbie Stabenow (D-MI), announced that she and Ranking Member Senator Thad Cochran (R-MS) will begin the process of reauthorizing the CFTC later this year. She encouraged CFTC officials to finalize rules and finish implementing the Dodd-Frank Act. Stabenow and Cochran will release a joint letter in the coming days that will invite public input on reauthorization.

View Statement in full here (links externally to AG Senate website).

SEC to Host Credit Ratings Roundtable, Releases Staff Report on Assigned Credit Ratings

The SEC announced that it will be holding a Credit Ratings Roundtable on May 14th in response to a recent staff report on credit ratings. The roundtable will be held at the Commission’s headquarters in Washington, D.C., and will be open to the public and webcast live on the SEC website.

Cross-Reference(s): Dodd-Frank Title IX (“Investor Protections and Improvements to the Regulation of Securities”).

See: SEC Press Release; Staff’s Report on Assigned Credit Ratings.
Additional News Item: SEC Report to Congress on Assigned Credit Ratings.

CFTC Chairman Gensler Lashes Out at LIBOR at CFTC Roundtable

In a statement before the CFTC Roundtable on Financial Market Benchmarks, CFTC Chairman Gary Gensler asserted the importance of moving to a more robust framework for financial market benchmarks, especially those for short-term variable interest rates.  Chairman Gensler further stated that LIBOR has been “readily and pervasively rigged,” and thus may no longer be grounded in real transactions. As to the future of LIBOR, he questioned whether the published rates had any meaning, given what he said was the very limited volume of unsecured interbank financing.  Chairman Gensler also discussed the need for procedures for transitioning from those benchmarks that have become unreliable or obsolete. 

Lofchie Comment:  As we have previously cautioned, firms should be developing backup plans to change the base rates of interest used in their documents, or should at least establish a procedure by which the base rates may be changed if existing benchmarks cease to be published.

View remarks in full here (links externally to CFTC website).
Link to corresponding news item as the statement of CFTC Commissioner Chilton: here.

CFTC Commissioner Chilton Calls for Benchmark Investigations

CFTC Commissioner Bart Chilton called for the systematic review of all major financial benchmarks during a statement he made before the International Roundtable on Financial Benchmarks on February 26, 2013. He expressed the need for a “governmental, quasi-governmental or not-for-profit” oversight of all the major marks used by the industry.  He specifically referred to the LIBOR, energy swaps, gold and silver fixes in London, and the “whole litany of bors.”  He went on to say that “every single [bench]mark needs to be reviewed, and potentially investigated.”

View Statement in full here (links externally to CFTC website).
Link to corresponding news item as the statement of CFTC Chairman Gensler: here.

MetLife Is No Longer a Bank Holding Company

On February 14, MetLife, Inc. announced it had completed its deregistration and is no longer a bank holding company.

This came as no surprise; more than two years ago the company made known its intentions (see here for a piece I wrote at the time) and since then has actively sought to shed banking-related assets. Yet its deregistration is significant, in part because it is at odds with the regulatory push to improve financial stability and reduce systemic risk. By shedding its bank holding company status, MetLife loses the Federal Reserve as its primary regulator.

As of 9/30/12, MetLife ranked 6th in total assets among the Top 50 holding companies (see current Top 50 list here). By virtue of its participation in the 2009 Supervisory Capital Assessment Program (SCAP), its size and holding company status meant that it would be required to participate in the upcoming round of Comprehensive Capital Analysis and Review (CCAR), the stress tests conducted by the Federal Reserve (see page 62381 and particularly footnote 19 of the Federal Register notice detailing this). MetLife was one of four companies that “failed” the CCAR in March 2012 and has been critical of both the stress tests and capital regulations being applied to insurance companies in the same way as banks.

Without its BHC status, it’s not clear that MetLife still will be subject to the next CCAR or the rigorous supervisory oversight that comes with being a BHC. Arguably the oversight of the insurance regulators and potential designation as systemically important by the Financial Stability Oversight Council will substitute.

MetLife was ahead of the game five years ago when a wave of companies scrambled to become bank holding companies in order to have access to the Fed’s lending facilites; unlike many of those other companies, MetLife had been a BHC well before that time.

In the immediate aftermath of the 2008 crisis, regulatory attention has focused on the risk the largely unregulated shadow banking system poses to financial stability. As a result the shadow banking system was hit hard, according to CFS estimates (see here) but more recently has shown signs of recovering. It just got a large boost from MetLife joining its ranks.

For more information on the shadow banking system, see:
Pozsar, Zoltan, Tobias Adrian, Adam Ashcraft, and Hayley Boesky (2010), “Shadow Banking,” Federal Reserve Bank of New York Staff Report No. 458, revised February 2012, available here (links to external NY Fed website).

Governor Tarullo on International Cooperation in Financial Regulation

Federal Reserve Governor Daniel K. Tarullo gave a speech discussing the cross-border effects of the financial crisis, existing efforts to strengthen international regulatory coorporation, and the next steps toward advancing global financial stability.  As to the causes of the financial crisis, Governor Tarullo pointed to (i) insufficiently high capital charges and a capital system that favored off-balance sheet activities such as the establishment of structured investment vehicles and (ii) a system of oversight that relied less on regulation than it did on supervision.  He also discussed “shadow banking,” significant examples of which he said include “money market funds, the triparty repo market and securities lending.”  The implication of his remarks was that all of these activities require stricter regulation. 

Governor Tarullo then laid out several principles for deciding upon the agenda that should govern the efforts of various international organizations and committees.  According to Governor Tarullo, (i) initiatives should be prioritized, and one point of emphasis should be completing and implementing the framework for containing “too-big-to-fail” risks associated with systemacally important firms; (ii) initiatives should be focused and manageable; and (iii) international efforts to develop new regulatory mechanisms should build on experience derived from national practice in one or more jurisdictions.

Governor Tarullo then suggested a number of short-term goals:

  • Two ongoing initiatives should be completed over the next year: the proposal for a capital surcharge for systemically important banking organizations, and work on designating non-bank SIFIs;
  • Regulators should build on the analytic work done by the Basel Committee to apply standardized credit and market risk capital measures to all internationally active banking firms; and
  • A requirement should be proposed for large internationally active financial institutions to have minimum amounts of long-term unsecured debt, which would be available to absorb losses in the event of insolvency.

Lofchie Comment:  This is one of those speeches that covers so much ground that its specific intent is not so clear.  On one hand, Governor Tarullo seemed wary of traditional lending activities being conducted in the same organization as capital markets activities.  On the other hand, he indicated that “large, free-standing investment banks” should be subject to “macroprudential regulation,” presumably meaning regulation, in the United States, by the Fed.   Here is a link to another of Chairman Tarullo’s significant speeches in which he covers ground also discussed in this speech:  Fed. Governor Daniel Tarullo on Industry Structure and Systemic Risk Regulation.

We also note that one of the Governor’s last major statements presaged the Federal Reserve Board’s proposal of major changes in the manner in which it would regulate non-U.S. banks doing business in the United States.  See Fed Governor Daniel Tarullo Speech on Regulation of Foreign Banking Organizations (Very Significant Speech);  FRB Releases Proposed Rules to Strengthen Oversight of U.S. Operations of Foreign Banks.

View speech in full here (links externally to Federal Reserve site).

SEC Director Tafara’s Speech: ”Crisis and Conflicts”

SEC Director of the Office of International Affairs Ethiopis Tafara elaborates on his views regarding “Growth, Stability and Sustainability” in the United States’ post-recession environment.  Tafara asserts that problems in the capital markets can be alleviated by restoring investor confidence in the integrity of the system. This, in Tafara’s opinion, would be accomplished through regulators focusing more on conflicts of interest and informational asymmetry problems rather than by adopting banking supervisory approaches, which he argues focuses on the limting of risk.  Mr. Tafara argues that the imposition of bank-like regulation on capital markets activities is inappropriate and will damage the economy by discouraging appropriate risk-taking.

Lofchie Comment:  Much of what Mr. Tafara says is appealing, and these days, I applaud any regulator who is willing to say in public that it is not necessary to impose every conceivable form of financial regulation on every conceivable financial institution.  However, to wear my pro-regulatory hat (and I do have one; I just don’t get to wear it much in this regulatory climate), I think Mr. Tafara underestimates the risks of runs on broker-dealers and mutual funds.  And to put my anti-regulatory hat back on, I worry that Mr. Tafara would give the regulators too much power (with a right to judge in retrospect) that a conflict of interest at a financial institution would be deemed a fraud. 

Right now, the regulatory system desperately needs regulators such as Mr. Tafara who are willing to discuss which regulations are appropriate (and which are not).

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

SIFMA Letter to SEC on Proposed Capital, Margin, and Segregation Rules

SIFMA submitted a comment letter to the SEC on its proposed rules on “Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers.” SIFMA emphasized the following recommendations to the SEC:

(i) the capital requirements are too high in light of both market and credit risks;

(ii) the rule discourages security-based swap dealers (“dealers”) from allowing the use of tri-party custodians by their customers;

(iii) the liquidity requirements in the rule will be extremely burdensome;

(iv) the SEC should consider eliminating initial margin requirements and replacing them with two-way variation margin requirements;

(v) certain counterparties (sovereign entities, regulated affiliates, SPVs) should not be required to post margin; and

(vi) the collateral segregation requirements will raise costs by effectively forcing dealers to use their own cash to fund customers’ positions or the hedging of those positions. 

Lofchie Comment:  While safety and soundness are the reasons for the imposition of many of the SEC requirements, the end result is that SEC registrants are going to have a very hard time competing against non-U.S. firms.  There are three issues that really drive competitiveness:  capital requirements, margin requirements, and ability to use posted collateral.  SEC registrants are going to be burdened as compared to their competitors on all three counts.  (See also my comments on the next item).

Link here to the page with the SIFMA comment letter (on the SIFMA website).