CFTC Commissioner Jill Sommers released a statement supporting Commissioner Wetjen’s proposal of an interim final guidance that would be based on industry and public feedback, after Chairman Gensler had criticized the idea of delaying cross-border rules at a Senate Appropriations hearing. (For those interested in viewing Chairman Gensler’s remarks, certain of the most significant aspects of Chairman Gensler’s responses to questioning from the Senators is from approximately 1:35 to 1:45 into the hearing, and comes particularly in response to Senator Johanns.)  Immediately following Chairman Gensler’s responses to questions, SEC Chairman White stated that the SEC would move in a more deliberate fashion than the CFTC and would consider comments on its proposed rulemaking.

Commissioner Sommers expressed her support for Commissioner Wetjen, and her general disagreement with Chairman Gensler  by stating, “No one has ever accused Gary Gensler of being reasonable, but Commissioner Wetjen has put a reasonable proposal [for delay of the cross-border rules] on the table that would achieve multiple goals.” 

The same story reported that six Democratic Senators had urged CFTC Chairman Gensler to delay the application of the CFTC’s cross-border rules. 

Lofchie Comment:  The criticism of Chairman Gensler comes in reaction to a number of statements made by Chairman Gensler, most particularly (i) his published statement on the imposition on cross-border regulation (linked below) and (ii) his responses to questions before the a subcommittee of the Senate Appropriations Committee (also linked below).

There were a number of aspects of Chairman Gensler’s responses to questions from the Senators on cross-border regulation that emphasized how significant the uncertainty is in this area. Three examples of this are below:

One, Chairman Gensler stated that the CFTC was open to a program of substituted compliance by non-U.S. financial institutions, yet at the same time indicated that no other jurisdiction had in place a comprehensive scheme of regulation that would justify substituted compliance. Taking these two aspects of his remarks together, one was left with the impression that the Chairman would not accept substituted compliance when the CFTC’s current exemptive order expires on July 12, although he did not say so directly. Does that mean that Chairman Gensler believes that all non-U.S. firms registered as swap dealers should be subject to the full range of U.S. regulation, at least for the intermediate future?

Two, as to Canada, he indicated that only two of the provinces had schemes of regulation for derivatives and the other provinces did not. Given that the major Canadian banks operate in more than one province, does that mean that the CFTC intends to regulate the major Canadian banks extensively for the long term?  

Three, Chairman Gensler indicated that non-U.S. funds with U.S. advisers should be treated as U.S. persons under Dodd-Frank. He did not indicate whether that would include funds with non-U.S. ownership or how funds with a mix of U.S. and non-U.S. ownership should be treated. Nor did he indicate whether he would accept European jurisdiction over funds with European advisers, if such funds had some degree of U.S. ownership. In other words, how does the CFTC intend to resolve with Europe the issue of regulatory citizenship where an entity has some links to both the United States and Europe?

The existence of the tremendous uncertainties inherent in the three above questions argues strongly for the CFTC not to impose a blackbox of cross-border rules on global markets on July 12, but rather to follow the SEC’s course in proposing a full cross-border rule, which would be published in the Federal Register, and available for comment.

As to the need for fast action by the CFTC,  one may see some tension in (i) on the one hand, the CFTC Chairman arguing the urgency of the cross-border regulation of swaps by the CFTC and (ii) on the other hand, on the same day, the CFTC bringing a civil action for the loss of $1 billion of customer money by one of the largest CFTC-regulated firms.

See: Bloomberg Coverage of Sommers Statement and Senators’ Letter.
See also:  Chairman Gensler’s Responses to Questions before the Senate; Chairman Gensler on International Swaps Market Reform.

Commissioner Wetjen delivered a speech at the FIA and FOA International Derivatives Expo discussing the global scope of the CFTC and the implementation of Dodd-Frank overseas.  The Commissioner’s speech focused on the final implementation of Dodd-Frank in the coming weeks, especially the legislation’s cross-border policy.  In his remarks, he outlined the main objectives which he believes the CFTC must reach through cross-border guidance and relief:

• The CFTC’s Cross-Border Policy Must Protect the U.S. Taxpayer and Financial System: The Commissioner stated that the financial crisis taught global citizens that financial activities which appear to be local can have global consequences. The CFTC’s cross-border policy will account for the varied ways that risk can be imported into the U.S. and the promotion of international harmonization.
• The CFTC Must Protect the U.S. Financial System but Avoid Fragmenting Liquidity and Creating Unfair Competitive Advantages for Some Firms and Markets: The Commissioner confirmed that the CFTC’s cross-border guidance and Dodd-Frank provisions will comply in appropriate cases with “comparable and comprehensive” foreign regimes. Furthermore, the Commissioner clarified the CFTC’s approach as it relates to transaction-level requirements including clearing, reporting, and execution.
• The CFTC Must Adopt a Cross-Border Policy That Is Clear and Workable, Which Requires an Orderly Transition Period: The Commissioner stated that the CFTC and other financial regulators must be willing to revisit any cross-border framework and remain open to a “course of correction,” as developments in global and domestic derivative markets dictate.
• The Commissioner closed by stating he believed that the CFTC should adopt “interim final guidance in the coming weeks and seek additional comment on an interim approach that provides the legal certainty needed for the markets in the short term. . . .”

Lofchie Comment:  The Commissioner delivered what seemed to be a thoughtful and reasoned speech as to the difficulties in adopting a workable scheme of cross-border regulation.  However, he then closed his remarks with recommendations that seemed inconsistent with the tenor of most of his speech.  It is now June 25th; the current guidance on cross-border issues expires on July 12th.  No one in the market (buy-side or sell-side), nor any non-U.S. regulator, has any clear notion of what a final CFTC rule on the cross-border application of Title VII will look like.  Yet the Commissioner believes that the CFTC can adopt a workable cross-border “rule” (which cannot be called a rule because it has not been through any of the legal formalities of rulemaking) before July 12th, and do so without the benefit of either public comment, or coordination with the SEC or non-U.S. regulators.

Such a course of action would be imprudent.  When the CFTC’s choices are either (i) rush to beat an artificially imposed three-week deadline that can be readily extended or (ii) extend the current guidance and use the delay to publish a carefully considered rule proposal that could be modified in light of comments from U.S. market participants and non-U.S. regulators, as well as coordination with the SEC, the second choice seems obvious.   That so much time has passed since the adoption of Dodd-Frank does not justify haste now.  That the CFTC has not yet published a carefully considered rule proposal on cross-border issues reflects the choices that the CFTC has made to date, not a result that was forced upon the CFTC.

See:  Commissioner Wetjen’s Full Remarks Here.
See also:  SIFMA Statement on Commissioner Wetjen’s Remarks on Cross-Border Treatment of Derivatives.

The Office of the Comptroller of the Currency (OCC) has issued a rule finalizing  amendments to 12 CFR Part 32, which governs lending limits.  The rule implements Dodd-Frank Section 610, which applies the lending limit statute to credit exposures arising from derivative transactions and securities financing transactions, and makes other changes.

Effective Dates:  Under the rule, a temporary exception period is extended for three months so that compliance with the Section 610 provisions will not be required until October 1, 2013.  The effective date of amendatory instruction 2b of this final rule is July 2.

See:  Final Rule Release.

The SEC is proposing two alternatives for amending rules that govern money market mutual funds pursuant to Rule 2a-7 under the Investment Company Act. The release provides a substantial discussion of the role of money market funds in the 2008 financial crisis, as well as some discussion of prior and subsequent valuation and liquidity problems experienced by money market funds.   According to the SEC, the two alternatives proposed by the SEC are designed to address money market funds’ susceptibility to heavy redemptions, improve their ability to manage and mitigate potential contagion from such redemptions, and increase the transparency of their risks, while preserving their benefits.

• Alternative One: Floating NAV – This proposed alternative would require that all institutional prime money market funds operate with a floating net asset value (“NAV”). This approach would preserve the stable value fund product for those retail investors who have found it to be convenient and beneficial.
• Alternative Two: Liquidity Fees and Redemption Gates – This proposed alternative seeks to directly counter potentially harmful redemption behavior during times of stress. Under this model, a non-government money market fund would impose a two percent liquidity fee (the SEC requested comment on the size of the fee) if the fund’s level of weekly liquid assets fell below 15 percent of its total assets unless the fund’s board determined that the fee was not in the best interests of the fund.  Additionally, redemption gates could be imposed.  In effect, an investor that wanted to obtain immediate liquidity in a period of market crisis would be assessed a substantial penalty on redemption, if it were able to redeem at all. 

The SEC could adopt either alternative by itself or a combination of the two alternatives. The SEC also is proposing additional amendments that are designed to make money market funds more resilient by increasing the diversification of their portfolios, enhancing their stress testing, and increasing transparency by requiring money market funds to provide additional information to the SEC and to investors. The proposal also includes amendments requiring the investment advisers to certain unregistered liquidity funds, which can resemble money market funds, to provide additional information about those funds to the SEC.

Government security money market funds and “retail” money money market funds might be exempted from the alternatives.  A “retail” fund would be defined as a fund that limited redemptions by any individual investor to $1 million a day.  The release contains an extensive discussion of how this $1 million limit might be monitored where investment in a money market fund is made through an omnibus account where the actual investors are not known to the money market fund. 

The release notes that the changes made in the regulation of money market funds would have ripple effects beyond the securities laws; e.g., they would effect the tax treatment of investments in such funds and they might potentially affect the accounting treatment of such funds.  In addition, the changes could significantly affect operational processes in the securities markets; for example, an investor purchasing shares on the stock market could not be assured that the cash required to pay for those shares could be raised by redeeming the number of money market shares equal to the number of dollars of cash required to pay for the shares.

Comments Due: September 17, 2013.

Lofchie Comment:  The release states that there is currently approximately $2.9 trillion invested in money market mutual funds.  The release notes that the changes in the money market fund rules will likely have a material effect on investment patterns; i.e., on whether that $2.9 trillion stays invested in money market funds, and, even to the extent it does, that the types of funds that receive investor money will change.  In short, the rule will materially affect not only investors and financial intermediaries but also issuers raising capital.  One other consequence may be an increased demand for government securities to be held by money market funds (as money market funds will be exempt from certain of the new requirements) at the same time that Dodd-Frank regulations also require market participants to post government securities as collateral in connection with derivative transactions.  The SEC appropriately concedes that the full effect of these proposed regulatory changes is impossible to predict. 

See: 78 FR 36834.
Related News: “SEC Open Meeting: Money Market Fund Reform (with link to Delta Strategy Description of SEC Meeting)”