SEC Releases Study to Congress on Credit Rating Agency Independence

The SEC Staff of the Office of Credit Ratings published a report regarding credit rating agency independence.  The report was submitted to the Committee on Banking, Housing, and Urban Affairs of the U.S. Senate, and the Committee on Financial Services of the U.S. House of Representatives, and is being submitted pursuant to Dodd-Frank Section 939C (“Securities and Exchange Commission Study on Strengthening Credit Rating Agency Independence”).

Part One of the report describes the independence of nationally recognized statistical rating organizations (“NRSROs”), and how such independence affects ratings issued by NRSROs, describes the annual examinations of NRSROs by the SEC, and reviews the U.S. and foreign regulatory rules for the provision of “ancillary services” by the credit rating industry.  “Ancillary services” are generally described as services other than the provision of  rating.

Part Two of the report includes an overview of the ancillary services provided by each of the ten NRSROs and the potential conflicts of interest involved, reviews the applicable policies and procedures that have been publicly disclosed by NRSROs regarding the ancillary services, and describes the results of relevant findings from recent annual NRSRO examinations.  The report concludes that the SEC staff has not found any material problems with the NRSROs’ management of conflicts of interest, and thus the staff did not recommend any tightening of the relevant rules.

See: SEC Report.
See also: All SEC Special Studies.


NASAA President Andrea Seidt Begins ”Campaign for Smarter Regulation”

NASAA President, Andrea Seidt, released a statement indicating NASAA’s new campaign to take advantage of technology in an effort to balance the legitimate interests of investors with the legitimate goals of entrepreneurs, and to adopt policies that are fair to both.

In her remarks, President Seidt states that NASAA has consulted with a task force of the American Bar Association to “develop a proposal that peels back some of our normal guidelines to accommodate this new type of offering.”  As part of the proposal, NASAA has designed a multistate review process, and is developing a multistate electronic filing platform that will allow one-stop filing with all states.

Lofchie Comment:  Any regulatory change that provides for coordination among the regulators to reduce the number of regulators with which a regulated entity must interact is a positive.

See: NASAA President Seidt’s Statement.


Governor Tarullo Delivers Speech Regarding Shadow Banking and Systemic Risk Regulation

Federal Reserve Governor Daniel K. Tarullo gave a speech at the Americans for Financial Reform and Economic Policy Institute Conference discussing the “shadow banking system” and its impact on systemic risk regulation. The speech focused in particular on the issues presented by short-term wholesale funding, and the pre-crisis rise in the creation of assets thought to be “cash equivalents.” Governor Tarullo described the short-term wholesale funding runs that began in 2007 as events that had a “cascading, self-reinforcing quality” that directly exacerbated financial stress, comparing those runs to the periodic deposit runs on banks that took place before the advent of deposit insurance. He acknowledged that the similarities between deposit runs and short-term wholesale funding runs have suggested, at least to some, that policy responses should be similar. Nevertheless, he argued that a regulatory approach requiring market actors to internalize the social costs of short-term wholesale funding would be preferable, and that a more comprehensive reform agenda is needed.

Governor Tarullo went on to discuss specific vulnerabilities presented by the shadow banking system, such as the difficulty in measuring the amount of “implicit support” that regulated institutions provide to shadow banking activities, and the concomitant difficulty in crafting an appropriate regulatory response. He surveyed two types of policy options to be considered in response to the vulnerabilities inherent in firms with large amounts of short-term wholesale funding: the first, to tie capital and liquidity standards together by requiring higher levels of capital for large firms that substantially rely on short-term wholesale funding, and the second, to address the macroprudential concerns arising from large matched books of securities financing transactions. He noted that these options would be directly applicable only to firms already subject to prudential regulation, and for that reason, those options would have to be supplemented by regulatory tools that could be applied on a market-wise basis; such regulation would focus on particular kinds of transactions, rather than the specific firms engaging in those transactions.

See: Governor Tarullo’s Speech.


CFTC Announces Weekly Swaps Report

CFTC Chairman Gary Gensler announced the initial edition of the CFTC’s Weekly Swaps Report, which will be published each Wednesday at 3:30 p.m. to provide the public with a detailed view of the swaps marketplace.

The Weekly Swaps Report uses data collected from swap data repositories (“SDRs”) in the interest rate asset class and credit asset class, and represents only those swaps that are reported to the CFTC’s registered SDRs by swap market participants. The Report currently incorporates data from three SDRs: CME Group SDR, DTCC Data Repository and ICE Trade Vault; however, data from additional SDRs could be incorporated in the future.

The report provides three views of the swaps market: the gross notional outstanding value, the weekly transactions measured by dollar volume, and the weekly transactions measured by ticket volume. For each asset class, the report provides detailed breakdowns of the swaps market by product type, currency (six major currencies), tenor, participant type, and whether swaps are cleared or uncleared.

The most recent report shows that over the last month, approximately 70 percent of new transactions in the interest rate swaps market were cleared. As of November 8, 2013, the outstanding notional amount of market facing interest rate swaps totaled $320 trillion, and 61 percent of those swaps were cleared. Just 21 percent of the interest rate swaps market was cleared in 2008.

Lofchie Comment: Comments are welcome (at regarding the value of knowing the ticket volume of swaps. Please weigh in on whether this information is worth the cost of collection.

See: CFTC Press Release; Weekly Swaps Report; Notional Outstanding Report; Transaction Volume Report.


Bretton Woods Viewed from India

The Internet now has many documents related to Bretton Woods that were unavailable when Andrew Rosenberg and I began our work on The Bretton Woods Transcripts a little more than two years ago. The latest that I have found is the Report of the Indian Delegation to the United Nations Monetary and Financial Conference at Bretton Woods, on the Reserve Bank of India’s recently established digital library site. The report, printed in 1945, stresses some particular concerns India raised at Bretton Woods, such as the convertibility of its pound sterling assets, the extent to which the IMF would stress economic development over balance of payments considerations, and quotas (capital subscriptions in the International Monetary Fund and World Bank). India, although still a British colony at the time of the Bretton Woods conference, was notable for the independent stance of its delegation, extending to the Englishmen who served on the delegation.

CFTC Chairman Gensler Cites Adam Smith

CFTC Chairman Gary Gensler spoke at the CME Global Financial Leadership Conference, focusing on past, current and future revisions to the regulations governing the swaps market.  As in his previous speeches, Gensler began by explaining how the swaps market has dwarfed the futures market and went on to describe the major reforms of the swaps market.

Asserting that Adam Smith had focused on the importance of market transparency in The Wealth of Nations, Gensler stated that the first major reform was making the swaps market more transparent. According to Gensler, the public can now see the price and volume of each swap transaction as it occurs. Gensler went on to discuss how the swaps market now has mandated central clearing for financial entities and dealers, and also spoke about reforms for swap dealers, such as new business conduct standards for risk management, the documentation of swap transactions, and recordkeeping and reporting.

Additionally, Gensler discussed the significance of international coordination on swaps market reform and developments regarding customer protection, particularly the set of customer protection rules which were recently finalized by the CFTC. He concluded by discussing the future of swaps market regulation, once again mentioning that the CFTC needs more resources to continue its work.

Lofchie Comment: CFTC Chairman Gensler’s references to Adam Smith as a source of intellectual support for the CFTC’s regulation of swaps seem misplaced. As an economist, Adam Smith is famous primarily for advancing the notion of the “invisible hand”; of relying on private economic decisions to achieve the greater good. This seems inconsistent with the government-driven regulatory structure mandated (in part) by Dodd-Frank and further advanced by Title VII as implemented by the CFTC.

As to Adam Smith, here is a representative quotation from Mr. Smith:

“The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever. . . .”

In fact, it seems that a more appropriate choice of economic philosopher for Title VII would be Nobel-prize winning economist Leonid Kantorovich. Here is a link to Mr. Kantorovich’s acceptance speech for his Nobel prize in economics in 1975: Mathematics in Economics: Achievements, Difficulties, Perspectives. Below is a quotation from the speech, which is illustrative of the theoretical economic difficulties raised by building grand regulatory structures that are created by government mandate.

“There appeared a necessity to shift from study and observation of [small-scale] economic processes and from isolated policy measures to systematic control of the economy, to the common and united planning being based on the common aims and covering a long time horizon. This planning must be so detailed as to include specific tasks to individual enterprises for specific periods and to that common consistency of the whole this giant set of decisions was guaranteed.”

The question for our system of financial regulation is the extent to which it is possible for the government or any centralized “intelligence” – even one managed by a Nobel prize-winner – to structure and maintain an efficient system that relies on heavy regulation in preference to the randomness of individual decision-making advocated by Adam Smith.

See: Chairman Gensler’s Speech.
Related speeches citing Adam Smith: CFTC Chairman Gensler Cites Adam Smith and Discusses Swaps Regulation (November 7, 2013); CFTC Chairman Gensler Cites Adam Smith in Defense of Dodd-Frank (November 1, 2013); CFTC Chairman Gensler Delivers Speech (October 30, 2013).


CFTC Issues Further Guidance on Application of Its Rules to SEFs

The CFTC Division of Market Oversight (“DMO”) has issued further staff “guidance” as to swap execution facilities (“SEFs”). The Guidance addresses six areas, including:

  • SEF/DCM registration requirements, which apply to multilateral swaps trading platforms located both in and outside the U.S. under CFTC Rule 37.3 (“Requirements and Procedures for Registration”) if the SEF is used for executions by either (i) non-U.S. persons located within the United States or (ii) U.S. persons through agents;
  • consent by clearing members to the jurisdiction of a SEF pursuant to CFTC Rule 37.700 (“Core Principle 7-Financial Integrity of Transactions”), which requires that SEFs “establish and enforce rules and procedures for ensuring the financial integrity of swaps entered on or through the facilities of the SEF, including the clearance and settlement of the swaps pursuant to Section 2(h)(1)” of the CEA;
  • a SEF’s use of proprietary data or personal information collected by the SEF from its market participants. The Guidance states that it is inconsistent with CFTC Rule 37.7 (“Prohibited Use of Data Collected for Regulatory Purposes”) for a SEF participation agreement or rulebook to contain a requirement that, in order to access the SEF, an eligible contract participant must consent to the SEF’s using data it collects from the ECP, including market data, propriety data, and personal data for business or marketing purposes;
  • clarification that a trade guarantee from a clearing member is required to satisfy CFTC Rule 37.700, but that an additional guarantee from a SEF member is not required;
  • a SEF’s definition of “emergency” situations must be consistent with the definition in CFTC Rule 40.1(h) (“Definitions”) and not broader than such definition; and
  • SEF reporting obligations, particularly the obligation that, when a SEF reports swap data, it must also report the legal entity identifier of the SEF.

Lofchie Comment: This “guidance” appears to represent a fairly remarkable extension of the CFTC’s jurisdiction, albeit subject to the usual questions as to whether the CFTC is acting in violation of the Administrative Procedures Act.

In the first instance, the “guidance” states that the “[Market Oversight] Division [of the CFTC] expects that a multilateral swaps trading platform located outside the United States that provides U.S. persons or persons located in the U.S. (including personnel and agents of non-U.S. persons located in the United States) . . . with the ability to trade or execute swaps on or pursuant to the rules of the platform, either directly or indirectly through an intermediary, will register as a SEF or DCM.” A footnote to this language indicates that the CFTC would consider various factors in determining whether a non-U.S. SEF would have to register, although the conditions in the footnote are entirely ambiguous and include phrases such as “a significant [but undefined] portion” and “generally include, but not be limited to.” In short, a SEF that does not exclude all trading by U.S. persons, or by non-U.S. persons who are present in the United States, is subject to CFTC registration. Further, according to the guidance, once a SEF registers, every clearing member of the SEF must be subject to the jurisdiction of the SEF, which has the effect of giving the CFTC indirect jurisdiction over the clearing member. In summary, the CFTC assert that it may have jurisdiction over SEFs everywhere in the world (even where no U.S. person can trade directly on the SEF) and over every clearing member of every such SEF. And it does so in the form of “guidance,” issued without warning or consultation, and not a rule.

This guidance is likely to have significant market consequences and draw international resistance from the CFTC’s global regulatory colleagues.

See: CFTC DMO Staff Guidance.
Related news: CFTC Issues Staff ”Guidance” on Impartial Access to SEFs (November 15, 2013); CFTC Issues Time-Limited No-Action Letter for FCMs and SEFs (13-62) (October 2, 2013); CFTC Issues Time-Limited No-Action Letter Relief for Temporarily Registered SEFs and Designated Contract Markets from the One-Business-Day Product Review Period Requirement (13-60) (October 2, 2013); Two CFTC No-Action Letters (13-55 and 13-56) on Swap Data Reporting (October 1, 2013); CFTC’s DMO Provides Time-Limited No-Action Relief to SEFs and Market Participants (September 30, 2013); CFTC Issues Staff Guidance on Swaps Straight-Through Processing (September 30, 2013).


House Financial Services Committee Chairman Criticizes CFTC Regarding Transaction-Level Requirements in Certain Cross-Border Situations

The House Committee on Financial Services Chairman Jeb Hensarling (R-TX) issued a statement criticizing the recent CFTC advisory letter related to cross-border swaps transactions. Chairman Hensarling expressed his concern that this surprise decision made by “unelected and unaccountable bureaucrats at the CFTC” will do nothing but introduce more uncertainty into America’s weak economy. He stressed that the CFTC staff, “not the commissioners, but the staff,” decided late Thursday afternoon that swaps transactions which were permissible that afternoon would no longer be permissible on Friday morning. He noted that this quick policy change is unfair to small businesses, farmers and manufactures that rely on cross-border transactions to stay in business. He stated that “this is another example of out-of-touch Washington bureaucrats making rules in a vacuum and acting with absolutely no regard for the impact their arbitrary and capricious actions have” on America’s economy. 

The House voted 301-124 to pass H.R. 1256, the Swaps Jurisdiction Certainty Act, which Chairman Hensarling stated is aimed at bringing certainty, clarification, and “some sanity” to the CFTC’s recent actions. He noted that the Senate has not acted on the bill, and stated that he believes this inaction will set the stage for market confusion and a small business disadvantage against foreign competitors. He closed by encouraging the Senate to vote on the bill to stop “misguided policy that will drive capital away from our shores, eliminate American jobs, and raise prices on consumers.” 

Lofchie Comment: The CFTC’s more recent action as to the application of its rules to non-U.S. SEFs, as discussed in today’s newsletter, would seem to raise even more questions about process and timing (as well as substance) than does the CFTC action criticized in the Representative’s statement.

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


CFTC Amends No-Action Relief to SDs and MSPs Regarding Intended-To-Be-Cleared Swaps (CFTC Letter 13-70)

The CFTC Division of Swap Dealer and Intermediary Oversight issued what is in effect an amended no-action letter as to the regulatory obligations of SDs and MSPs regarding “Intended-To-Be-Cleared Swaps.”  Essentially, this letter restates prior Letter 13-33, except that it amends the prior letter to take account of the CFTC staff’s “guidance” that where a trade is expected to be cleared, but is not, the trade is deemed void ab initio and neither party is permitted to charge a breakage fee.  The relief in this letter, as in the prior letter, goes to certain requirements under the external business conduct rules and CFTC Rule 23.504 (“Swap Trading Relationship Documentation”). The letter states that no person may rely upon the relief provided in Letter No. 13-33 after November 15, 2013.

Lofchie Comment:  It certainly seems that there are Administrative Procedures Act issues here.  On June 27, 2013, the CFTC issued “no-action letter” 13-33, which provides “The eligible account manager . . . [is required] to be responsible for any obligations of the counterparty . . . [as to] trade breakage costs. . . ”  (We put “no-action letter” in quotation marks, because Letter 13-33 appears to be in many respects a rulemaking, not a no-action letter.)  Then, on September 26, the CFTC staff issued “guidance” that it is improper (illegal?) to charge breakage costs in connection with a swap that is expected to be cleared, but is not.  Then, on November 15, the CFTC staff withdrew, without any time notice, the discussion of breakage costs in Letter 13-33.

See: CFTC No-Action Letter 13-70.
Related News: Staff Guidance on Swaps Straight-Through-Processing