OTC Derivatives Report to the G-20 Meeting of Finance Ministers and Central Bank Governors

The principal authorities with responsibility for the regulation of the over-the-counter (“OTC”) derivatives markets in Australia, Brazil, the European Union, Hong Kong, Japan, Ontario, Quebec, Singapore, Switzerland and the United States, issued a report discussing the reform of the OTC derivatives market.

Here is the key paragraph in the report:

“The principals also recognise that conflicting or inconsistent cross-border application of rules to market participants, intermediaries, infrastructures and products may inhibit the execution or clearing of certain cross-border transactions or impose additional compliance burdens.  The principals further recognise that regulatory gaps may present risks to financial markets and provide the potential for regulatory arbitrage.”

Lofchie Comment:  The report reads like a negotiated peace treaty between the CFTC and the rest of the world or, if not a treaty, at least a statement that the warring parties make before entering into treaty discussions.  As a practical matter, I would think this statement gives some hope that the CFTC will delay implementing any final cross-border “guidance” until it has negotiated further understandings with non-U.S. regulators and, hopefully, the SEC.

View Report in full here (links externally to CFTC website).
See also: Press Release.

Who’s Too Big to Fail – Statement by FDIC Director Wigand, and Acting General Counsel Osterman, Jr.

The Federal Deposit Insurance Corporation (“FDIC”) released a statement by James R. Wigand, Director, Office of Complex Financial Institutions, and Richard J. Osterman, Jr., Acting General Counsel, on “Who Is Too Big to Fail?” examining the application of Title I of the Dodd-Frank Act. This is essentially a statement of the purposes in requring large banks to develop “living wills” and the progress that the largest financial institutions have made in developing these wills.  Mr. Alvarez’s speech discussed the measures being taking to reduce the probability of failure by a large bank, particularly higher capital requirements, and focused significantly on liquidity requirements.

View speech in full here (links externally to FDIC website).
See also: General Counsel Scott G. Alvarez’s Speech.
See also:  Board and FDIC Provide Additional Instructions for Submission of Some Resolution Plans.

Growth Stalls and Shadow Banking: Just Released Money Supply Data

CFS Divisia M4 (DM4) growth in March slowed for the third consecutive month.

The March advance is stronger than nearly every month last year. However, economic strength witnessed at the end of 2012 and early this year may be losing momentum.

Shadow banking liabilities such as repurchase agreements, institutional money market funds, and commercial paper are demonstrating divergent trends early in 2013.

For Monetary Notes and Views:

For Monetary and Financial Data Release:

Next month’s release will be on Wednesday, May 22nd at 9:00 a.m.

Commissioner Chilton Speech: ”Kaleidoscopes”

CFTC Commissioner Chilton gave a speech in which he repeated the themes he has emphasized in the past: (i) that “massive passives” drive up the price of commodities to irrational levels and (ii) that high-speed traders have an unfair advantage over low-speed traders.

Lofchie Comment:  Commissioner Chilton attempts a very important task, which is to link economic theory to regulatory policy.  I don’t think that one can meaningfully debate regulatory policy without some view of economic theory.  In fact, one of the themes of his speech is that different people may perceive the same events (or the market) differently based on their own perspectives.  Consistent with Commissioner Chilton’s openness to opposing views, even directly opposing views, I hereby offer up some contrasting perspectives.       

As to the fact that massive passives inevitably drive up the price of commodities, here is a link to a story from today’s Washington Post titled “Stocks, commodity prices fall sharply as traders worry about a slowdown in China’s growth.”  As to the theory that passive long positions in derivatives drive up underlying commodity prices, here is a contrasting view from Paul Krugman. 

As to the view that high-speed trading is bad because it allows a fast trader to take action ahead of a slow trader, what regulatory policy is Commissioner Chilton advocating as a corrective measure? Perhaps he is asserting that all traders should use the same technology so that none has an advantage over any other, but he has not stated exactly what steps he would take to slow down those who have better technology. Further, it seems inconsistent with an American view of fostering competition in markets for regulators to prevent the use of a technology simply because it was faster or better.

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

Subcommittee Discusses Bipartisan Bills to Fix Dodd-Frank Derivatives Provisions and to Require Cost-Benefit Analyses

Various measures to fix the unexpected consequences of derivatives provisions in the Dodd-Frank Act, and to require the Securities and Exchange Commission (“SEC”) to conduct cost-benefit analyses of regulations, were discussed during a hearing today of the Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises.

The following is a summary of the legislation which the subcommittee discussed:

  • H.R. 634, the Business Risk Mitigation and Price Stabilization Act of 2013, introduced by Reps. Michael Grimm (R-NY), Gary Peters (D-MI), Austin Scott (R-GA) and Mike McIntyre (D-NY), would exempt end users from the margin and capital requirements of Title VII of the Dodd-Frank Act.
  • H.R. 677, the Inter-Affiliate Swap Clarification Act, introduced by Reps. Steve Stivers (R-OH), Marcia Fudge (D-OH), Chris Gibson (R-NY) and Gwen Moore (D-WI), would exempt inter-affiliate trades from the Dodd-Frank Act’s margin, clearing, and reporting requirements.
  • H.R. 742, the Swap Data Repository and Clearinghouse Indemnification Act of 2013, introduced by Reps. Rick Crawford (R-AR), Sean Patrick Maloney (D-NY), Bill Huizenga (R-MI) and Gwen Moore (D-WI), would remove an indemnification requirement imposed on foreign regulators by the Dodd-Frank Act as a condition of obtaining access to data repositories.
  • H.R. 992, the Swaps Regulatory Improvement Act, introduced by Reps. Randy Hultgren (R-IL), James Himes (D-CT), Richard Hudson (R-NC) and Sean Patrick Maloney (D-NY), would repeal most of Section 716 of the Dodd-Frank Act. Section 716 (also referred to as “Lincoln” or “push-out”) prohibits “federal assistance” – defined as “the use of any advances from any Federal Reserve credit facility or discount window . . . [or] Federal Deposit Insurance Corporation insurance or guarantees” – to “swaps entities,” which include swap dealers and major swap participants, securities and futures exchanges, swap-execution facilities, and clearing organizations.
  • H.R. 1062, the SEC Regulatory Accountability Act, introduced by Capital Markets Subcommittee Chairman Garrett (R-NJ), would direct the SEC to follow President Obama’s Executive Order No. 13563, which requires government agencies to conduct cost-benefit analyses to ensure that the benefits of any rulemaking outweigh the costs.
  • H.R. 1256, the Swap Jurisdiction Certainty Act, introduced by Reps. Garrett (R-NJ), John Carney (D-DE), Michael Conaway (R-TX) and David Scott (D-GA), would require the SEC and CFTC to jointly issue rules relating to swaps transacted between U.S. persons and non-U.S. persons.
  • H.R. 1341, the Financial Competitive Act of 2013, introduced by Rep. Stephen Fincher (R-TN), requires the Financial Stability Oversight Council (“FSOC”) to study the likely effects of the differences between the U.S. and other jurisdictions in implementing the derivatives credit valuation adjustment (“CVA”) capital requirement.

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

Board and FDIC Provide Additional Instructions for Submission of Some Resolution Plans

The Federal Reserve Board (“Board”) and the Federal Deposit Insurance Corporation (“FDIC”) have jointly issued the release of additional guidance, clarification and direction for the first group of institutions that filed their resolution plans pursuant to the Dodd-Frank Act.

These 11 institutions filed their initial resolution plans with the Federal Reserve Board and the FDIC in 2012. Plans were required generally from U.S. bank holding companies with $250 billion or more in total nonbank assets, and foreign-based bank holding companies with $250 billion or more in total U.S. nonbank assets. Following review of the initial resolution plans, the agencies have developed instructions for these institutions to detail further information which should be included in their 2013 resolution plan submissions.

View Guidance in full here (links externally to Federal Reserve website).
See also: Press Release.

CPSS and IOSCO Publish Consultative Report on Global Authorities’ Access to Trade Repository Data

The Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) have published for public comment a consultative report entitled Authorities’ access to trade repository data. The purpose of the report is to provide guidance to trade repositories (TR) and authorities on access to TR-held over-the-counter derivatives (OTCD) transaction data for typical and non-typical data requests, as well as possible approaches to addressing confidentiality concerns and access constraints. The report considers that a broad range of authorities (i.e. market regulators, central banks, prudential supervisors and resolution authorities), as well as official international financial institutions, are interested in obtaining access to data reported to TRs in order to perform their responsibilities.

The report describes the expected data access needs of authorities using a functional approach complemented by an illustrative data access mapping that aligns each function to the minimum level of access authorities would typically require in support of their mandates and responsibilities. In addition, the report proposes access guidelines that aim to provide TRs and regulators with a framework upon which to build access policies. The data access mapping table provides a means for mapping access rationales to access levels.

Since the data mapping table for each mandate describes the minimum level of access that an authority exercising that mandate would typically require, the report advises that it should not be taken as definitive. The report states that the needs of authorities will likely continue to evolve, and authorities may find that the descriptions of their respective mandates do not adequately describe the full range of their data access needs. Given the continuous evolution in the OTCD markets, TRs will need to develop data access procedures that are sufficiently flexible along different dimensions, including the composition of typical data requests and reported attributes for specific OTCD classes. The framework and guidelines should provide useful guidance in making and responding to such requests and the implementation of data access policies by TRs.

Click here to view Consultative Report (links externally to IOSCO website).

Chairman Gensler Remarks on Libor and Other Benchmarks before the U.S. Chamber of Commerce

CFTC Chairman Gary Gensler delivered remarks before the U.S. Chamber of Commerce Seventh Annual Capital Markets Summit regarding the need to move on from the continued use of LIBOR, Euribor and similar benchmark interest rates. Chairman Gensler said the shift away from banks funding each other in the unsecured market (without posting collateral) has led to a scarcity or outright absence of actual transactions underpinning LIBOR and other benchmark rates.  As a result of having benchmark rates not anchored in actual transactions, he said that market integrity has been undermined and the financial system has been prone to misconduct.

View remarks in full here (links externally to CFTC website).

Bill Poole on the Budget

Former St. Louis Fed President William Poole wrote an extremely thoughtful and provocative opinion piece in WSJ this morning – A Primer for Understanding Obama’s Budget.  The piece finds fault in the budgeting process across generations and party lines.

Sadly, there is no independent entity to report a reasonable baseline for benchmarking.  It is simply too costly.

So…perhaps…it is time for the Federal government to get the math right.

Chairman Walter on Regulation of Cross-Border OTC Derivatives Activities

SEC Chairman Elisse Walter delivered remarks at the American Bar Association Spring Meeting in Washington, D.C., discussing her approach to the cross-border regulation of derivatives.

Chairman Walter posited that there were four potential approaches that the SEC could take to the cross-border regulation of swaps.  First, the SEC could simply allow non-U.S. swap dealers to do business in the United States only subject to their own home country legal requirements.  Second, the SEC could subject non-U.S. swap dealers to the full body of U.S. regulation.  Third, the SEC could allow non-U.S. swap dealers to do business in the United States only if their local rules were deemed to be fully comparable to U.S. rules.  Fourth, the SEC could allow non-U.S. swap dealers to do business in the United States subject to home country rules to the extent the SEC deemed those rules sufficient, and subject to the SEC’s rules where the SEC believed that there was a home country gap. 

Chairman Walter endorsed the fourth approach and explained her practical considerations in so doing.  She also made clear that the fourth approach, which she called “substituted compliance,” differered very substantially from the CFTC’s original use of the term, in that she did not anticipate a rule-by-rule review, but rather a broader overview of rules of a certain type.  She also expected that the SEC would take into consideration the way that rules were enforced, in particular jurisdictions, in addition to the way in which they are written. 

Lofchie Comment:  Chairman Walter has established a reasonably practical direction for the SEC to take in establishing the direction of cross-border swaps regulation.  (I also note that Chairman Walter’s tenure in that position is limited, as Mary Jo White’s nomination as Chairman was approved today by the Senate.  Assuming that new Chairman White agrees with Chairman Walter’s views, then. . . .)

One question will be whether the CFTC will fall in with the SEC or continue to assert a much more expansive view of its own authority over non-U.S. swap dealers.  It is likely that the CFTC will fall in line with the SEC (it has already been making a quiet retreat in that direction) because (i) it is fundamentally not workable for the CFTC and the SEC to regulate the same issue in completely opposing manners and (ii) the CFTC’s approach is not acceptable to non-U.S. regulators for the reasons set out in Chairman Walter’s speech.  That said, Chairman Walter’s direction will not be easy to implement; it will require U.S. regulators (who are already overburdened) to attempt to compare, on an ongoing basis, the U.S. regulation of swaps with their regulation in other jurisdictions, and then to adopt rules to fill in the gaps where the swap dealer rules in some other jurisdiction are deemed to fall short.  I am not aware of any model for the financial regulators attempting to regulate in this manner, so the SEC will be charting a novel course.

For non-U.S. financial firms, what this means is that they should be gearing up to educate their home country regulators to make the argument to the SEC and the CFTC that their home country rules are sufficient, and require little or no supplement from the U.S. regulators.  Of course, non-U.S. financial firms can make these arguments directly to the U.S. regulators, but the arguments will be made far more effectively if they are advanced by home country regulators.

For U.S. financial firms (and non-U.S. ones as well), they must give consideration as to how to structure their businesses globally.  Dodd-Frank imposes material and needless burdens on both swap dealers and swap customers. U.S.-based swap dealers will have to consider whether they can compete to do business with non-U.S. customers unless they operate out of a separate non-U.S. entity.  There is growing concern is that U.S.-based swap dealers effectively will be required to move their non-U.S. swap activities abroad in order to be competitive.  Certainly, all firms should be considering where business can be best conducted and, in this regard, should be planning how to hire personnel and build systems where it makes sense to do so.  Big picture:  we seem to be moving toward a regulatory culture where it will be advantageous to establish booking entities in numerous jurisdictions and do business with local customers, rather than to establish global booking entities.

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