Senate Banking Subcommittee Holds Hearing on Annual Report and Oversight of OFR

The Senate Banking Committee, Subcommittee on Economic Policy, held a hearing, titled “The Annual Report and Oversight of the Office of Financial Research (“OFR”),” to discuss the 2013 OFR Annual Report and its evaluation of the state of the U.S. financial system, as well as the September 2013 Asset Management and Financial Stability Report. 

Lofchie Comment:  Since its release, the Asset Management and Financial Stability Report has drawn substantial criticism from market participants and lawmakers.  For example, immediately after conceding that the activities of asset managers differ from those of banks by being activities that are conducted on an agency basis, the OFR report states: 

“[S]ome types of asset management activities are similar to those provided by banks and other nonbank financial companies, and increasingly cut across the financial system in a variety of ways. For example, asset managers may create funds that can be close substitutes for the money-like liabilities created by banks; they engage in various forms of liquidity transformation, primarily, but not exclusively, through collective investment vehicles; and they provide liquidity to clients and to financial markets.”

Remarkably, this assertion seems to ignore the statement made in the prior paragraph: that asset managers act only as agents – while they may manage vehicles that “provide liquidity,” they do not do so themselves.  In blurring this essential distinction, the OFR has called its own work into question.  

In addition, SEC Commissioner Piwowar has accused the Financial Stability Oversight Committee (“FSOC”), of which OFR is a part, of improperly intruding into the SEC’s authority over investment advisers.  See .

It is not clear whether there is any link between the OFR Report, which suggests that large investment advisers might be topics of systemic regulation, including capital regulation, and the recent NFA proposal that commodity trading advisers be required to maintain capital.

See: OFR Asset Management and Financial Stability Report; 2013 OFR Annual Report; SEC Commissioner Piwowar Speaks on SEC Priorities and Issues of Regulatory Structure (in which Commissioner Piwowar criticizes the FSOC for intruding into the SEC authority over advisers). 

Related news: SIFMA AMG and IAA Criticize OFR Report on Asset Management (November 5, 2013).


IOSCO Publishes Recommendations Regarding the Protection of Client Assets

The International Organization of Securities Commissions (“IOSCO”) published a final report titled “Recommendation Regarding the Protection of Client Assets,” which provides regulators with recommendations on the protection of client assets at regulated intermediaries, as well as a survey of the client protection regimes of 20 worldwide jurisdictions.

The survey includes client protection regimes from Australia, Brazil, Canada, France, Germany, Hong Kong, India, Italy, Japan, Korea, Mexico, the Netherlands, Pakistan, Poland, Romania, Singapore, Spain, Turkey, the United Kingdom, and the CFTC and SEC, separately. The International Organization of Securities Commissions (“IOSCO”) published a final report titled “Recommendation Regarding the Protection of Client Assets,” which provides regulators with recommendations on the protection of client assets at regulated intermediaries, as well as a survey of the client protection regimes of 20 worldwide jurisdictions.

The survey includes client protection regimes from Australia, Brazil, Canada, France, Germany, Hong Kong, India, Italy, Japan, Korea, Mexico, the Netherlands, Pakistan, Poland, Romania, Singapore, Spain, Turkey, the United Kingdom, and the CFTC and SEC, separately.

See: IOSCO Press Release; IOSCO Report: Recommendation Regarding the Protection of Client Assets.

SEC Commissioner Piwowar Speaks on SEC Priorities and Issues of Regulatory Structure

SEC Commissioner Piwowar delivered remarks to the U.S. Chamber of Commerce, focusing on a broad range of topics, particularly:  (i) priorities for the SEC and (ii) the intrusion of other political interests into the mission of the SEC and (iii)  the relationship between the SEC and other regulators, particularly FSOC.

Priorities for the SEC:

Commissioner Piwowar described five areas that should be the focus of the SEC’s efforts to advance its core mission:

  • engage in a comprehensive multi-year review of equity market structure which would consider the effects of high-frequency and algorithmic trading on market structure;  
  • create a pilot program for alternative minimum tick sizes for small capitalization companies;
  • make incremental fixed-income market structure changes “for the benefit of investors and issuers,” and develop proposals to improve how fixed-income markets operate, including improved price transparency and disclosure of mark ups on fixed income transactions;
  • continue to move forward with initiatives to curb the “unhealthy over-reliance” on proxy advisory firm recommendations, which Piwowar believes “shifts fiduciary duty from the advisers to the proxy advisory firms;” and
  • comply with the Executive Order signed by the President in 2012 to conduct ongoing retrospective analyses of existing rules in order “to determine whether any such regulations should be modified, streamlined, expanded, or repealed.” 

Other Topics of the Discussion

Commissioner Piwowar did not specify particular rules that the Commissioner viewed as inconsistent with the SEC’s focus on disclosure for the benefit of investors (but it may be reasonably assumed that he was referring to the requirement that the SEC adopt rules on compensation ratios and perhaps also to the rules relating to conflict minerals).

Additionally, the Commissioner worried that the SEC’s authority within its regulatory space was being threatened by other regulators, particularly the Financial Stability Oversight Council, which he described as  an organization that “represents an existential threat to the SEC and the other member agencies.”  In particular, he singled out for criticism a “study” (his quotes) that FSOC had prepared on the asset management industry.

Lastly, Commissioner Piwowar turned to the issue of money market regulation and mentioned very briefly some of the alternatives being considered by the SEC.

Lofchie Comment:  Commissioner Piwowar becomes the second of the SEC Commissioners to severely criticize FSOC.  See also Commissioner Gallagher’s remarks on FSOC.  One of the primary assertions made by Commissioner Piwowar is that financial regulation has become too much a tool for political ends and that FSOC is far too partisan since its’ constituent organizational representation does not reflect appropriate participation by representatives of the minority party. Politics and partisanship portend a bleak future for financial regulation – one in which financial regulation is motivated by electoral rather than economic considerations.

See:  Commissioner Piwowar’s Speech.


Market Participants File Statement to Explain Their Standing in Lawsuit Challenging CFTC Cross-Border Guidance

In response to the Court’s request, the ISDA, SIFMA and the Institute of International Bankers (“IIB”) (together, the “Associations”) filed a statement and declarations explaining to what extent the Associations have standing to bring a regulatory challenge against the CFTC’s Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (the “Cross-Border Rule”). 

Previously, the Associations filed an amended complaint against the CFTC on December 27, 2013, which asserted that the Cross-Border Rule and related actions were issued in violation of the Administrative Procedure Act (“APA”).  Along with filing an amended complaint, the Associations submitted a procedural motion seeking expedited consideration of a motion for summary judgment and, at the same time, the CFTC filed a motion to delay the summary judgment, stating that it needed time to brief a motion to dismiss the complaint.   During the status conference of the case on January 14, 2014, according to the submission, the Court had expressed doubt that standing is a genuine issue, but requested that the Associations provide “something short, ten pages or less, explaining to what extent does one need to worry about standing” as to the 14 Title VII Rules accompanying the Cross-Border Rule. 

In response to this request, the Associations stated that there is “little question” about the standing to bring a regulatory challenge, and provided declarations from six members affirming that the Association’s members “have suffered actual injury as a result of both the Cross-Border Rule and the extraterritorial application that the Commission evidently contends the Title VII Rules have of their own force.”

See:  SIFMA Statement and Declarations Regarding Standing
See also:  SIFMA Opposition to CFTC Motion to Hold in Abeyance; CFTC Motion to Hold in Abeyance; SIFMA Motion for Expedited Consideration of Summary Judgment; SIFMA v. CFTC Amended Complaint; SIFMA Motion for Summary Judgment; SIFMA v. CFTC Civil Docket.
Related news:  Market Participants File Opposition to CFTC’s Motion to Delay Judgment in Lawsuit Challenging CFTC Cross-Border Guidance (January 17, 2014); Market Participants File Amended Complaint Challenging CFTC Cross-Border Guidance (January 8, 2014); Market Participants File Lawsuit Challenging CFTC Cross-Border Guidance for Being a Rule Adopted in Violation of the APA (December 4, 2013); CFTC Commissioner O’Malia Dissents from CFTC Cross-Border Guidance Statement (July 19, 2013); CFTC Approves Cross-Border Guidance and Exemptive Order (July 15, 2013).


CFTC Issues Trade Execution Mandate for Additional Interest Rate and Credit Default Swaps

The CFTC Division of Market Oversight (“DMO”) certified TW SEF LLC’s (“Tradeweb”) self-certification of certain interest rate swap and credit default swap (“CDS”) contracts that have been made available-to-trade (“MAT Determinations”). The CFTC stated that swaps subject to MAT Determinations, whether offered by trueEx or any other swap execution facility (“SEF”) or designated contract market (“DCM”), will become subject to the trade execution requirement under CEA Section 2(h)(8) (“Jurisdiction of Commission; Liability of Principal for Act of Agent; Commodity Futures Trading Commission; Transaction in Interstate Commerce”) 30 days after certification. In the case of these interest rate swap contract MAT Determinations, the requirement will be effective as of February 26, 2014.

As a result of this certification, the CFTC stated that transactions involving the specific IRS contracts and CDS contracts will be subject to the trade execution requirement, effective February 26, 2014, in addition to the IRS contracts that will be subject to the trade execution requirement on February 15, 2014, and February 21, 2014, respectively.

The CFTC noted that all transactions involving swaps that are subject to the trade execution requirement must be executed through a DCM or SEF, including swaps that are part of so-called “package transactions,” or groups of transactions that are executed together for price coordination or other reasons.

Lofchie Comment:  This process seems rushed.  There is no risk to the system in permitting rate swaps to be traded on the OTC market for the short run, even assuming that there is some benefit to forcing them to be traded on SEFs in the long run.  Accordingly, it would seem to make more sense to force a limited group of trades on SEFs as an experiment, and to work out any kinks in that process, if there are any, before deciding how to proceed.  Query:  how confident are the regulators that problems (e.g., an inability of firms to trade) will not arise in the process?  What are the benefits versus the risks of moving quickly?

See:  TW SEF Approval and Fixed-to-Floating Interest Rate Swap Table.
Related news:  CFTC Issues Trade Execution Mandate for Certain Interest Rate Swaps (January 21, 2014).
Other related news:  MFA Comment Letter to CFTC on SEF Trading Rules and Onboarding Documentation (January 10, 2014);  MFA Submits Suggestions to CFTC on MAT Submissions (November 26, 2013); SIFMA and ISDA Criticize SEFs’ Made-Available-to-Trade Submissions (November 25, 2013); CFTC Extends Comment Period on Certification from Javelin SEF to Implement Available-to-Trade Determinations (November 4, 2013); SEF Seeks Determination of Mandatory Exchange Trading of Swaps (October 21, 2013).


CFTC Commissioner O’Malia: ”It’s Time to Review Our Rules and Make Necessary Changes”

CFTC Commissioner Scott O’Malia delivered remarks to the Commodity Markets Council, discussing areas of regulation that he believes the CFTC must address and reform, including technology and data, swap trade execution and the impact of rules on end users. 

According to O’Malia, if the CFTC does not invest in and improve its technology, “major oversight functions will be severely impaired.”  He stated that the CFTC is making progress towards improving the quality of its data, citing a recent announcement that the CFTC will establish a cross-divisional team to identify data utilization problems and recommend appropriate solutions.  Additionally, O’Malia noted that, beginning in March, the CFTC will provide a comment period for market participants to offer suggestions to improve reporting so that the data team can make recommendations to the CFTC in June.  He stated that he hopes the CFTC will reengage with various jurisdictions that have trade data repositories in an attempt to find a global solution to data reporting, and noted that the EU reporting rules will become effective on February 12, 2014.  

O’Malia went on to discuss the progress of swap trade execution, stating that it is still unknown whether swap execution facilities (“SEFs”) will become the “spitting image” of a designated contract market (“DCM”).  O’Malia noted that it is important to remember that Dodd-Frank did not intend for SEFs to look like DCMs, and stated that the CFTC must “resist the temptation to impose a one-size-fits-all approach to SEF platforms.”  According to O’Malia, the CFTC should encourage trading on SEF platforms while simultaneously protecting the efficiency of trading various combination products. 

Additionally, O’Malia discussed the importance of protecting end users.  According to O’Malia, Congress gave the CFTC two “competing” objectives:  reducing systemic risk in the derivatives market and protecting end users.  O’Malia stated that, while attempting to reduce systemic risk, the CFTC “has neglected to safeguard end-users from costly compliance” with regulations.  O’Malia cited the swap dealer rule as one that should be revisited to provide end users with greater clarity – in particular, the de minimis threshold and the “Special Entity” definition.  Additionally, O’Malia explained that end users have struggled to determine whether a volumetric option is a forward or a swap, and suggested that volumetric options be redefined to create “reliable and well-defined safe harbors.” 

According to O’Malia, the CFTC also failed to consider the impact of a number of rules on end users due to “lack of appropriate cost-benefit analysis,” including Rule 1.35 (“Records of Commodity, Interest and Related Cash or Forward Transactions”) and the position limits re-proposal.  O’Malia stated that both of these rules impose unfair burdens on some end users who lack the resources to comply, and the CFTC “must consider revising the rule to offer cost-effective alternatives, not another barrage of reflexive no-action letters.” 

Lofchie Comment:  The first task of the incoming Chairman of the CFTC must be to clean up the rules. There will only be greater confusion as the agency presses on with further rulemaking on so shaky a foundation. If the CFTC loses its case on whether the “Interpretative Guidance” on cross-border issues was a rule adopted in violation of the Administrative Procedures Act (as it should), the foundation will largely crumble.

Commissioner O’Malia’s comments on SEFs are worthy of serious consideration.  While there is a good argument to be made that the whole notion of mandatory SEF trading is entirely misplaced (as SEF trading has nothing to do with systemic risk), it would seem that, given that SEFs are intended to be venues for sophisticated investors to trade, the rules applicable to SEFs should be materially less restrictive than those which are applicable to retail markets.  Instead, the CFTC’s rules applicable to SEFs are largely identical to rules applicable to retail markets, raising the following question: what is the point of a separate system of institutional regulation if that system is identical to the retail system?

See: Commissioner O’Malia’s Speech.


SEC Chair White Establishes 2014 SEC Priorities

SEC Chair Mary Jo White delivered the keynote address at the Securities Regulation Institute, speaking about some of the “transformative” changes at the SEC in 2014, including rulemakings on the upcoming SEC agenda. 

Chair White outlined the new technologies that the SEC is utilizing to keep up with the financial market’s evolving technology and provide market participants and stakeholders with better access to data, as well as providing faster and more useful analytics for the SEC. According to White, NEAT (“National Exam Analytics Tool”) assists the SEC in systematically and quickly analyzing massive amounts of data. She also noted that the Market Information Data Analysis System (“MIDAS”), collects and time-stamps billions of trading data and formats them into charts and graphs for market participants. Chair White also explained that the SEC will implement new rules that focus on market technology, such as Reg. SCI (“Systems Compliance and Integrity”), which would place new and stricter requirements for the use of technology by exchanges, large alternative trading systems, clearing agencies and securities information processors.

As to swaps regulation, Chairman White said that the bilateral swaps market will become a transparent, centrally cleared market.  Additionally, White stated that the SEC is evaluating proposals for financial products, money market funds and asset-backed securities that will address specific concerns that impacted the financial crisis.  The proposals include measures to prevent runs on money market funds and finalize new rules under the JOBS Act to reduce systemic risks from asset-backed securities.

Chair White went on to explain that, in 2014, the SEC will reconsider how companies can seek capital and communicate with investors, stating that the SEC is “at the start of what promises to be a period of transformative change in capital formation.”  She noted the enthusiasm for updated capital formation and crowdfunding rules, and stated that she expects the SEC to “move expeditiously” to finalize new Reg. A (“Conditional Small Issues Exemption”) rules.  In order for the agency to monitor the expanding private market, she said that an agency-wide working group has been formed to monitor offering practices and other developments in the Rule 506 market.

Finally, White stated that the SEC is not confined to rulemaking or market oversight, noting that it is necessary for the SEC to maintain its rigorous enforcement policy.  One policy she seeks to maintain is the admission of guilt in settlements against financial wrongdoers.  She stated that, although settlements provide swift and important remedies for firms and individuals who commit financial crimes, it is important that the SEC maintain public accountability and acceptance of responsibility for enforcements.  She stated that, in 2014, the SEC will pursue more cases that involve admissions of guilt. 

See:  SEC Chair White’s Speech.


SEC Commissioner Gallagher Discusses Corporate Disclosure System and Proxy Advisory Industry

SEC Commissioner Daniel M. Gallagher delivered a speech at the Forum for Corporate Directors, focusing on reforms for the corporate disclosure system and the proxy advisory industry. 

Commissioner Gallagher stated that, while the SEC is a disclosure agency, and it is important for information about public companies to be made available to the public, there is such a thing as too much disclosure.  According to Commissioner Gallagher, the complexity of today’s disclosure requirements gives the SEC cause for self-examination, and he would “prefer to address discrete issues now rather than risk spending years preparing an offensive so massive that it may never be launched.”

He suggested “practical issues” on which the SEC should focus, including “layering disclosure,” which is based on the recognition that some information is inherently material, such as a company’s financial statements and some is not, such as pay-ratio calculation.  Gallagher also noted that the SEC should explore the potential of technology to help improve corporate disclosure, as well as make efforts to recognize politically motivated disclosure mandates.

Commissioner Gallagher also discussed the role of the proxy advisory industry, which he has frequently spoken about in the past.  According to Gallagher, the “outsized role” that proxy advisory firms have gained in corporate governance is largely a result of the unintended consequences of SEC action.  Gallagher stated that the SEC roundtable on proxy advisory firms in December 2013 was an important first step toward proxy advisory reform, but that there is still much work to be done in considering the next steps. 

See:  Commissioner Gallagher’s Speech.


FRB Provides Additional Information for Large Bank Holding Companies as to Resolution Planning and Recovery

The Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System (“FRB”) issued a letter titled Principles and Practices for Recovery and Resolution Preparedness to clarify the heightened supervisory expectations for recovery and resolution preparedness for eight domestic bank holding companies that may pose elevated risk to U.S. financial stability. The letter states that the eight bank holding companies should have effective processes for the management, identification, and valuation of collateral received. Additionally, the letter sets out specific guidance which includes the following:

  • effective processes for managing, identifying, and valuing collateral it receives from and posts to external parties and affiliates;
  • a comprehensive understanding of obligations and exposures associated with payment, clearing, and settlement activities;
  • the ability to analyze funding sources, uses, and risks of each material entity and critical operation, including how these entities and operations may be affected under stress;
  • demonstrated management information systems capabilities for producing certain key data on a legal entity basis that is readily retrievable, with controls in place to ensure data integrity and reliability; and
  • robust arrangements in place for the continued provision of shared or outsourced services needed to maintain critical operations that are documented and supported by legal and operational frameworks.

Lofchie Comment:  Although the guidance is only legally binding on the eight bank holding companies, it makes sense for all firms that are dependent on the receipt or delivery of collateral to review the recommendations of the banking regulators.

See:  Principles and Practices for Recovery and Resolution Preparedness; Press Release.