IOSCO Research Department Launches Statistics Web Portal on Securities Markets

The Research Department of the International Organization of Securities Commissions (“IOSCO”) launched a statistics web portal that will provide a global overview of specific securities markets.  IOSCO stated that the new statistics web portal seeks to provide a centralized point for monitoring global trends, risks and vulnerabilities and will serve as a mechanism for comparison of how well markets are recovering in light of the crisis.  The data will be updated on a monthly basis. Key statistics the portal will cover include:

  • corporate debt;
  • covered bonds;
  • securitized products;
  • Islamic finance;
  • equity IPO volumes;
  • equity market valuations;
  • syndicated loans; and
  • housing price indices.

See: IOSCO Press Release.


Bretton Woods: Who Was Eduardo Suárez?

The Bretton Woods conference was divided into three working groups called commissions. Commission I, on the International Monetary Fund, was chaired by Harry Dexter White of the United States Treasury. Commission II, on the International Bank for Reconstruction and Development (World Bank), was chaired by John Maynard Keynes of the United Kingdom. Commission III, on other means of international financial cooperation, was chaired by Eduardo Suárez of Mexico. Keynes is known to everyone; White is known to everyone interested in Bretton Woods; but Suárez is not well known outside of his native country. Who was he?

Eduardo Suárez Aranzolo was born on January 3, 1895 in Texcoco, in the State of Mexico (which adjoins the federal district of Mexico City). As a youth he studied law, with the aid of a scholarship granted by the government of the state of Hidalgo. At age 22 he became an official in that government. After unsuccessfully running for a seat in the state legislature, he taught international law, eventually becoming a chaired professor at Mexico’s leading university. He also frequently acted as a consultant to the national government, including on a U.S.-Mexican commission and representing Mexico at the League of Nations. He participated in drafting important Mexican laws relating to the central bank, credit, and labor in the early 1930s.

Suárez was Secretary of Public Finance and Credit under two Mexican presidents from 1935 to 1946. His tenure in the office remains the second longest on record (after Antonio Ortiz Mena, who served from 1958 to 1970). He can be considered the founder of what has been termed the “developmentalist” school of thought in Mexican economic policy making. Two important events during his tenure were a rise in the world price of silver in 1935 that made Mexican silver pesos worth more as metal than as money, and the nationalization of foreign oil companies by president Lázaro Cárdenas in 1938.

After his time as a top official, Suárez resumed his career as a lawyer and also became an adviser to a number of businesses. He served as Mexico’s ambassador to Britain from 1965 to 1970. He died on September 19, 1976.

According to Luis Machado, a Cuban delegate to the Bretton Woods conference  who later became an executive director of the World Bank, Suárez was considered as a prospect to be the second president of the bank after its first president, the American Eugene Meyer, resigned. Ultimately the post went to another American, John J. McCloy.

Suárez’s son helped gather material for a posthumous collection of writings entitled Commentarios y recuerdos (1926-1946) (Comments and Memories, 1926-1946), published in Mexico City in 1977. Readers who know Spanish may also be interested in this reminiscence of Bretton Woods 50 years later by the technical secretary of the Mexican delegation, Victor L. Urquidi.

CFTC Issues No-Action Letter Providing Relief to Non-U.S. SDs from Certain CEA Transaction-Level Requirements (CFTC Letter 13-71)

The CFTC Divisions of Swap Dealer and Intermediary Oversight, Clearing and Risk, and Market Oversight have issued a time-limited no-action letter that provides relief to swap dealers (“SDs”) registered with the CFTC that are established under the laws of jurisdictions other than the U.S. (“Non-U.S. SDs”) from certain transaction-level requirements under the CEA.

On November 14, 2013, the CFTC issued an Advisory (Letter 13-69) in response to inquires from swap market participants regarding the applicability of the CFTC’s Transaction-Level Requirements in certain situations. Subsequent to the issuance of the Advisory, concerns were raised by certain Non-U.S. SDs regarding compliance with the Transaction-Level Requirements who said that, in order to avoid market disruption for their non-U.S. counterparties, additional time would be necessary to come into compliance.

Letter 13-71 provides no-action relief to Non-U.S. SDs until January 14, 2014, subject to the limitations set forth in the letter.

Lofchie Comment: This letter is illustrative of a number of problems with the CFTC’s approach to “rule” making.

First, the terms of the underlying requirements are entirely unclear. What does it mean to say that a non-U.S. person who “regularly” arranges, negotiates or executes swaps through persons in the United States is “generally” subject to Transaction-Level Requirements? Does “regularly” refer to a volume of swaps (and if so, what volume?) or to a number of personnel (and if so, what number?) or to a frequency (every day?)? What does it mean that a person would be “generally” required to comply? (Does that mean on some swaps? Does that mean that there are some conditions which would make compliance inapplicable?) What does it mean to “arrange” a swap? It would seem to mean something more than a referral, but there is no explanation of the term.

Second, the statement that the Divisions have not recommended any enforcement action against a non-U.S. swap dealer for failing to comply with any applicable Transaction-Level Requirements that does not conform to the CFTC’s swap guidance seems inconsistent with the statement made at the hearing where the CFTC adopted that guidance. At that meeting, it was expressly stated that the guidance did not constitute a rule which could form the basis of an enforcement action. Here, the Divisions seem to be assuming that the CFTC’s guidance is effectively a rule that can be violated, which would seem to imply that that the guidance was adopted in violation of the Administrative Procedures Act.

Third, the CFTC’s constant establishment of unworkable deadlines followed by last-minute no-action letters is simply no way to run an economy.

See: CFTC Letter 13-71.
Related news: CFTC Issues Advisory on Applicability of Transaction-Level Requirements in Certain Cross-Border Situations (CFTC Letter 13-69) (November 15, 2013).


Senators Send Letter to White House Regarding CFTC Commissioner Nominees

Nine Senate Democrats sent a letter to the White House urging the President to consider a nominee for CFTC Commissioner “who has the expertise, independence, and track record necessary to carry forward strong implementation of the derivatives reforms” of Dodd-Frank.

President Obama will have to nominate a new Commissioner to replace Bart Chilton, who announced that he will be stepping down on the same day that Timothy Massad was named to succeed Chairman Gary Gensler. According to the letter, the Senators are “deeply concerned” that some in the industry will view Gensler and Chilton’s departures as “opportunities to roll back or slow down essential reforms required by the Dodd-Frank Act.” In particular, the Senators are concerned that the industry will push the CFTC to:

  • reopen the London Loophole and weaken key rules that prevent the risk of swaps traded through foreign subsidiaries of American firms from flowing back to the U.S. taxpayer;
  • delay or weaken the “Volcker Rule” and other rules that protect taxpayers;
  • loosen the limits on speculative trading in oil, energy and other commodities markets;
  • allow major swap dealers in energy and commodities to avoid registration requirements;
  • weaken requirements that most swap trades be cleared through central clearinghouses and traded on transparent execution facilities; and
  • curtail enforcement activities deterring fraud, market manipulation and other market abuses.

The Senators urged the President to quickly nominate a candidate who has demonstrated knowledge in futures, options and swaps markets, as well as the skill and independence to continue progress on vital derivatives markets reforms, “even in the face of extremely stiff industry lobbying.”

Lofchie Comment: This seems an odd letter in a couple of respects. First, it could be read as critical of the President’s nomination of Timothy Massad to head the CFTC, implying that he has not “demonstrated expertise in futures, options and swaps markets” as called for in the letter. (Here is a link to Mr. Massad’s bio on the Treasury website.) Second, the statement that the CFTC’s refusal to share information with FERC is “unacceptable” seems to be a very severe criticism directed at CFTC Chairman Gensler, who is elsewhere praised.

Where I differ with the substance of the letter is in its assumption that a CFTC leader with experience, skills and independence in the derivatives markets would “ensure progress” on the various measures advocated by the Senators. There seems to me a good possibility that a person with such a deep skill set would be more concerned that forcing a greater volume of swaps on central clearing houses would increase systemic risk by centralizing tremendous amounts of credit in a few locations, forcing swaps onto untested swap execution facilities would dry up liquidity, and imposing position limits that lack an academic basis on energy markets would result in increased prices and volatility as “real commodity end users” found that their trading partners had diminished. While I recognize that reasonable persons may differ on these issues, what seems clear to me is that the Senators’ certainty on the positions that they advocate is too great and, thus, it would benefit even advocates of their positions to be mindful that their theories as to the way the markets function may not prove correct. By way of example, in another one of today’s news items, we cite a speech by Federal Reserve Governor Powell who says that “concentrating risk in a central counterparty could create a single point for failure for the entire system.” (See Fed. Governor Jerome H. Powell Delivers Speech Regarding OTC Market Infrastructure Opportunities and Challenges, November 25, 2013). In short, a little less confidence may be in order.

See: Senators’ Letter to the President.
Related news: Timothy Massad Nominated for CFTC Chairman (November 13, 2013).


Streetwise Professor Craig Pirrong on CFTC Rule Regarding CCP Qualifying Liquid Resources

Economist Craig Pirrong has written a commentary analyzing the new CFTC Rule 39.33, which mandates that Treasury collateral be subject to a “prearranged and highly reliable funding arrangement.” The rule, which requires systematically important clearing organizations (“SIDCOs”) to maintain sufficient liquidity resources, does not treat U.S. Treasury securities as a qualifying liquid resource. Instead, such organizations can count government securities towards their liquid resources only if they are backed by highly reliable funding arrangements such as committed lines of credit from banks. Thus, under the CFTC rule, Treasuries will no longer be treated as equivalent to cash. Pirrong argues that this requirement makes little economic sense, since Treasuries are a better source of liquidity than bank credit lines during times of financial stress. He also states that mandating that SIDCOs obtain lines of credit from banks will impose substantial costs on such CCPs in the form of capital charges, increase the interconnectedness among financial institutions that serve as a source of contagion from derivatives defaults, and undermine incentives of SIDCOs to demand the posting of high quality collateral.” Pirrong concludes by stating that, given the cost of the mandated credit lines, the rule will constitute “a dead weight burden on the markets.”

See: All Pain, No Gain: The CFTC’s Rule on CCP Qualifying Liquid Resources,” Streetwise Professor.
Related news: CFTC Issues Final Rules for Derivatives Clearing Organizations to Align with International Standards (Pre-Fed. Reg.) (November 18, 2013).


SEC Commissioner Piwowar’s Remarks on Enforcement and Rulemaking Issues

SEC Commissioner Michael Piwowar gave a speech focusing on the SEC’s enforcement as well as its rulemaking programs. On the subject of enforcement, Commissioner Piwowar first discussed informal and formal orders of investigation. He explained that informal investigations do not need SEC approval, but generally rely on voluntary information. Formal investigations, on the other hand, need SEC approval to authorize members of the staff to conduct investigations, including the administration of oaths and affirmations and the power to subpoena. Commissioner Piwowar went on to explain that, in 2009, the SEC had delegated to Division of Enforcement the authority to issue formal orders of investigation, which had in turn sub-delegated that authority to a good number of individual supervisors (whom he implied were not that senior). In light of this, he said he raised concerns as to whether this process is sufficient for the SEC to exercise an appropriate level of oversight of the formal order process, particularly in light of the very significant injury that an individual may suffer from being the subject of an investigation, even if the investigation is eventually dropped or the individual is exonerated.

Commissioner Piwowar went on to make observations regarding the issue of retroactivity, which he described as pertaining to cases involving conduct that occurred before changes in a law or regulation governing the legality of the conduct or remedies were available. Commissioner Piwowar stated that, in many cases, the SEC applies the relevant standard at the time of conduct. However, Commissioner Piwowar explained, the SEC has taken a different approach when imposing collateral bars, which prohibit a person from associating in capacities other than those in which the defendant was associated at the time of the violative conduct. Commissioner Piwowar expressed his concern with this standard, stating that he generally disfavored the application of retroactive collateral bars, as he viewed them as inherently unfair.

Finally, Commissioner Piwowar discussed the importance and necessity of high-quality economic analysis to rulemaking. This analysis, he explains, helps to ensure that decisions to propose and adopt rules are informed by the best available information about a rule’s likely economic consequences. This allows the SEC “to meaningfully compare the proposed action with reasonable alternatives, including the alternative of taking no action.” In addition, he voiced his strong support for Dodd-Frank Section 912 (“Clarification of Authority of the Commission to Engage in Investor Testing”), which clarifies the SEC’s authority to obtain certain data and information without needing to be approved under the Paperwork Reduction Act. Commissioner Piwowar stated that the disclosure of empirical data should inform the rulemaking process, which should not rely exclusively on the beliefs and opinions expressed in comment letters. He explained that the empirical data methods should be used regarding the rulemaking proposal for Reg D offerings in order to produce a more effective rule for investors and customers.

Lofchie Comment: This is a serious speech which embodies the values of fairness and economic rationality that market participants want to see in their regulators. It is encouraging that a regulator advocates for caution in the bringing of formal orders of investigation, recognizing that they can be devastating for the individual who is the subject of the investigation. Most market participants support the notion that, to the extent feasible, rules should be adopted on the basis of considered empirical support. SEC Commissioner Piwowar’s provides a model of thoughtful financial rulemaking going forward.

See: Commissioner Piwowar’s Speech.

MFA Submits Suggestions to CFTC on Made-Available-to-Trade Submissions

The Managed Futures Association (“MFA”) submitted a comment letter to the CFTC in response to the “made available to trade” (“MAT”) submissions of Javelin SEF, LLC; trueEX, LLC; and TW SEF LLC for certain interest rate swap products.

The MFA letter proposed that the CFTC phase in the trade execution requirement on registered swap execution facilities (“SEFs”) and designated contract markets (“DCMs”) by product and transaction type for the rates asset class, beginning with outright, spot-starting, USD and EUR swaps at the benchmark tenors in the fixed-to-floating interest rate swap class. This initial phase would be followed by progressively phased expansion of the trading mandate to include additional currencies, tenors and forward start dates in the fixed-to-floating swap class, as well as to other swap classes.

The MFA also recommended a similar phase-in to cover “package transactions” (as opposed to outright swaps). The letter compared the MFA’s recommendations to the Javelin SEF, trueEX and TW SEF MAT determinations. Additionally, the MFA letter raised certain operational readiness issues for SEF/DCM trading that the CFTC should address in connection with the phase-in of the trading mandate.

Lofchie Comment: Essentially, the MFA recommends that the CFTC reexamine the extremely low standards that it has established for allowing SEFs to force trading of swaps onto a SEF. Instead, the MFA recommends the CFTC take a more measured approach, in which market participants would effectively experiment with SEF-trading of those swaps having the highest volume. If that goes well, more trades could move onto SEFs gradually. According to the MFA, the CFTC would not be required to amend its rules in this regard; the CFTC could, in effect, temporarily nullify its prior rulemakings through the “issuance of staff no-action relief” (at pages 3-4).

The MFA’s idea of an approach to mandatory SEF trading – that it makes sense to proceed slowly and carefully – is entirely rational and is consistent with the approach urged by SIFMA and the sell-side as well. One could object, as a procedural matter, to the notion that the CFTC should amend its rules through staff no-action letters, but the reality is that the CFTC did not seem to give any serious consideration to the original rulemaking or it would have foreseen the risks raised by the MFA. It would serve the greater good if the CFTC did not risk damaging the markets (as well as the reputation of the CFTC as a regulator) with a massive experiment of which there have been a minimum of trials. See prior comments on this topic here.

See: MFA Comment Letter.


SEC Commissioner Stein Sets Her Regulatory Priorities

SEC Commissioner Kara M. Stein delivered remarks to the American Bar Association Business Law Section’s Federal Regulation of Securities Committee Fall Meeting on how regulators should proceed to ensure efficient regulation in capital markets.

Commissioner Stein stated that the SEC should begin by completing statutorily mandated rules such as the Volcker Rule. Stein conceded that finalizing this rule has not been an easy task since five federal agencies are charged with implementing the rule. Additionally, Stein noted, “The rule we are evaluating now is not the rule that I would have written,” although, she added, she hopes that it will be reformed and finalized by next year’s meeting. Stein also mentioned that the JOBS Act rules, Crowdfunding rules, and Reg A+ should be prioritized and finalized.

Stein went on to list other areas of regulation that should be addressed on a qualitative and quantitative level, such as market microstructure and technical glitches, the role of the proprietary data feeds, and the role of “dark pools.” Stein noted that a good first step in assessing these areas is the SEC’s MIDAS initiative, which collects relevant market data. Stein also mentioned that the SEC is working on completing the Consolidated Audit Trail (“CAT”) to increase the amount of data which the SEC can use to address problem areas.

Commissioner Stein also addressed the question of “how to deal with the mismatch between short-term funding sources and long-term liabilities.” Stein stated that, despite a lot of attention, money market funds are only one part of the funding ecosystem, and regulators must ensure that businesses have capital when they need it by examining the incentives that drive the selection of funding sources, such as preferential tax, accounting and bankruptcy treatment.

She went on to mention the work of the Public Company Accounting Oversight Board (“PCAOB”) and its approach to improving audit quality through increased auditor transparency. Additionally, Stein stated, while she is a proponent of personal accountability, the question of whether audit partners should be named in reports where their opinion appears must be addressed.

See: Commissioner Stein’s Speech.

SIFMA and ISDA Criticize SEFs’ Made-Available-to-Trade Submissions

SIFMA and the International Swaps and Derivatives Association, Inc. (“ISDA”) submitted comments to the CFTC regarding the available-to-trade submissions by Javelin SEF, LLC and trueEx, LLC for certain interest rate swaps, pursuant to CEA Section 5(c) (“Common Provisions Applicable to Registered Entities”) and CFTC Rule 40.6 (“Self-Certification of Rules”). According to the letter regarding Javelin, SIFMA and ISDA do not believe the Javelin submission is ready for action in its current form because it “lacks the specificity needed” to determine whether it meets the six factors set out in CFTC Rule 37.10(b) (“Process for a Swap Execution Facility to Make a Swap Available to Trade”) and the listing requirement set out in CFTC Rule 37.10(a)(2).

Regarding the trueEx submission, SIFMA and ISDA support trueEx’s “contract-by-contract approach” with respect to the six factors set out in CFTC Rule 37.10(b), and believe that trueEx should show that it will meet the listing requirements in CFTC Rule 37.10(a)(2) by demonstrating how it will support trading of the Submission Swaps.

Additionally, SIFMA and ISDA requested that the CFTC address the cross-border and packaged swap issues, which the agencies believe will become more important as a result of an available-to-trade determination.

Lofchie Comment: When the CFTC adopted its rules regarding “made available to trade,” it seemed that the standard that the CFTC was setting, by which all trading in a particular swap could be forced onto a SEF, was remarkably low. Thus there seemed to be a great danger to the financial markets that SEF trading might not function as expected, yet the CFTC would have prohibited OTC trading of swaps, with the risk of severely impeding the market’s ability to trade.

There are two causes for concern: (i) the CFTC has not conducted any inspections of the SEFs to determine if their technology functions properly – so far, its entire supervisory system consists of a cursory review of their various rule filings – and (ii) the CFTC’s “rules” governing SEFs are moving targets, with very new material “guidance” issued only last week as to how these markets are supposed to function. This results in even less certainty as to how SEFs will function.

Given all the technology mishaps that have occurred this year (from those involving Knight, to the Facebook IPO, to the recent problems in the options markets), the standard that the CFTC has established for forcing all OTC trading in a particular type of swap onto a relatively novel and essentially unsupervised SEF market seems imprudent. In this regard, it would seem the better course of action would be for the CFTC not only to attend to the cautions of swap market participants as expressed in the SIFMA/ISDA letter but, more fundamentally, to reconsider whether it has established reasonable procedures for forcing OTC trading onto SEFs.

To put this concern into perspective, the Bank for International Settlements reported that, in June of 2013, there were $561,299 billion in notional amounts of swaps outstanding. When the CFTC adopted the rules by which it would require all swaps of a certain type to be traded on a SEF, the CFTC estimated that the SEF would be required to undertake a study that would cost $938.40 in order to demonstrate that the government should mandate SEF trading (and prohibit OTC trading). 78 Fed. Reg. 33621 (June 4, 2013). The disproportion between the size of this market and the extent of the study is stunning. It seems incomprehensible that a government regulator would mandate moving a long-established market of that size onto a completely novel trading venue on the basis of a study that would cost less than a thousand dollars ($61.60 less than a thousand dollars). Certainly, if a private market participant were to undertake such a drastic action on the basis of a study that cost $938.40, they would be subject to government criticism.

See: Comment Letter Regarding Javelin Submission; Comment Letter Regarding trueEX Submission.
Related news: CFTC Extends Comment Period on Certification from Javelin SEF to Implement Available-to-Trade Determinations (November 4, 2013); trueEX Certifies Available-to-Trade Determinations for Certain Interest Rate Swaps (October 23, 2013); SEF Seeks Determination of Mandatory Exchange Trading of Swaps (October 21, 2013).


Fed. Governor Jerome H. Powell Delivers Speech Regarding OTC Market Infrastructure Opportunities and Challenges

Federal Reserve Governor Jerome H. Powell gave a speech discussing recent regulatory efforts to reform the OTC derivatives markets and, in particular, those reforms which are intended to strengthen market infrastructure by expanding the use of central clearing counterparties (“CCPs”) and introducing margin requirements for bilateral OTC derivatives. With respect to the role of CCPs, Governor Powell touted their ability to mitigate risk exposure and improve market transparency, but acknowledged that concentrating risk in a central counterparty could create a single point of failure. To that end, Governor Powell set forth three keys to ensuring that CCPs could effectively mitigate systemic risk:

  • enhance central counterparty supervision and regulation by, for example, strengthening the minimum risk management standards applied to infrastructures such as CCPs;
  • promote sound credit risk and liquidity risk management; and
  • promote the stability of central counterparty members through enhanced capital and liquidity requirements, such as Basel III.

On the subject of noncleared derivatives, Governor Powell noted that the Basel Committee and the International Organization of Securities Commissions recently finalized a framework for margin requirements on noncentrally cleared derivatives, and that regulatory authorities in participating countries are in the process of developing margin rules in light of that framework.

Lofchie Comment: The speech linked below highlights some of the risks created by central clearing, including that of “concentrating risk in a central counterparty [that] could create a single point of failure for the entire [financial] system.” One of the problems raised is that the central clearing party will not have sufficient margin to withstand a liquidity crisis. A related concern is that, in a time of market crisis, the central counterparty will demand excessive margin from its clearing members so as to keep itself safe. Those margin demands will have the potential to suck liquidity out of the rest of the financial system. What makes this particularly troubling is that market participants cannot protect themselves by contract from the demands of a central counterparty; i.e. the counterparty has the right to increase its margin levels at any time.

Another admission highlighted in the Governor’s speech relates to the probability that the CFTC may mandate that all swaps of a certain type be forced off of the OTC markets and onto SEFs. The Governor said: “It should also be noted that these margin requirements are new to the market and their effects cannot be fully understood before they become effective. There is simply no substitute for experience.” In light of that observation, does it really make sense to force all OTC trading of rates on SEFs in one fell swoop? What happens if there is a problem?

See: Governor Powell’s Speech.