CFS DM4 Signaled GDP Downward Revision…

CFS Divisia M4 has proven to be a strong leading indicator of GDP growth. It also provides the most comprehensive real time assessment of the US financial system.

This morning’s downward revision of Q4 GDP data from 3.2% to 2.4% should come as no surprise. The pace of the economy also demonstrated a slowdown from a 4.1% saar expansion in Q3.

On the heels of the September CFS monetary release, we wrote Soft Spot for Financial Institutions and Economy – October 16, 2013.

The weather was clearly not the predominant story in Q4.

Based on our latest data, the economy will likely continue to soften (see CFS Monetary & Financial Data Release, February 19, 2014 or End of the Free QE Lunch, February 19, 2014 – available on request)

Mercatus Scholars Issue Study Quantifying Dodd-Frank’s Regulatory Restrictions

Mercatus scholars Dr. Patrick McLaughlin and Robert Greene published a study quantifying the regulations in Dodd-Frank to determine the number of new restrictions the Act has created and will continue to create.

By applying the methodology of “RegData,” which relies on the content of the regulatory text as a data source, McLaughlin and Greene’s study estimated that Dodd-Frank will increase financial industry regulatory restrictions by 32 percent, yielding more new restrictions than were created between 1997 and 2010.

According to the study, it is important to note that most Dodd-Frank rulemakings have yet to be finalized, and that new rules could be more or less restrictive than the rules adopted through the end of 2011. Assuming that the remaining regulations are proportionately restrictive, however, the study estimates that Dodd-Frank would create a total of 16,543 new restrictions.

Lofchie Comment:  Staying positive, there is considerable upside to 16,543 new restrictions, if you are a regulatory lawyer.

Click here to view the study, “Dodd-Frank’s Regulatory Surge: Quantifying Its Regulatory Restrictions and Improving Its Economic Analyses,” by Patrick McLaughlin and Robert Greene


SEC Releases Memo and Reopens Comment Period for Asset-Backed Securities Disclosure Data and Registration

The SEC has reopened the comment period for its proposal to amend the disclosure and registration requirements applicable to asset-backed securities (“ABS”) in order for interested parties to comment on a new approach for the dissemination of potentially sensitive asset-level data. 

In 2010, as part of what the industry referred to as Regulation AB II, the SEC proposed to require ABS issuers to file standardized asset-level information on EDGAR in prospectuses and, on an ongoing basis, in periodic reports.  Although the SEC noted that requirements to disclose credit scores, income, debt and other information could raise privacy concerns, the SEC also noted that such information would permit investors to perform better risk and return analyses of the underlying assets and, therefore, of the ABS.

The proposals were re-proposed in July 2011 and comments were received in 2012.  Commenters expressed a wide range of privacy concerns.  In response, the SEC issued a new proposal that would require issuers to make asset-level information available to investors and potential investors through a website that would allow issuers to restrict access to information to ensure the security of sensitive information.  The SEC is reopening the comment period to solicit comments on this latest proposal.

Comments must be submitted by March 28, 2014.

Commissioner Piwowar issued a statement of support regarding the SEC’s decision to reopen the comment period.  He explained that market practices have evolved substantially since the original proposals were first published in 2011, making it necessary for the SEC to obtain more recent data.  Specifically, Commissioner Piwowar requested that interested parties comment on (i) whether asset-level data is, in fact, necessary for investors to independently perform due diligence on Auto ABS and other types of non-MBS offerings; and (ii) whether market participants understand their obligations under the described approach to handle sensitive asset-level data.  Additionally, he requested comment on any associated quantitative or qualitative benefits and costs to the markets as they exist today.

See:  SEC Memorandum; SEC Release Reopening Comment Period; Commissioner Piwowar Statement.


NFA to Incorporate CFTC Risk Management Program Requirement for FCMs

The National Futures Association (“NFA”) submitted to the CFTC proposed amendments to NFA Compliance Rule 2-26 (“FCM and IB Regulations”) to incorporate the CFTC’s Risk Management Program Requirement for futures commission merchants (“FCMs”). 

CFTC Rule 1.52(c)(1) (“Self-Regulatory Organization Adoption and Surveillance of Minimum Financial Requirements”) requires the NFA to adopt rules prescribing risk management requirements for FCMs that “are the same or more stringent” than the requirements in CFTC Rule 1.11 (“Risk Management Program for FCMs”).  To comply with CFTC Rule 1.52(c)(1), NFA is amending Compliance Rule 2-26 to specify that any Member who violates CFTC Rule 1.11 will be deemed to have violated an NFA requirement. FCMs are currently required to file their initial risk management program with the CFTC and the FCM’s designed self-regulatory organization (“DSRO”) by July 12, 2014.

The NFA invoked the “ten-day” provision of CEA Section 17(j) (“Registered Futures Associations”), indicating that the proposal will become effective ten days after the receipt of the submission by the CFTC, unless the CFTC determines that it will review the proposals for approval.

Lofchie Comment:  There is a fair amount of attention paid in the securities law literature to the relationship between the SEC and the securities industry self-regulatory organizations.  Less attention has been paid to such a relationship in commodities laws, in part because the CFTC has exercised less authority over the futures SROS than the SEC has exercised over the securities SROs, and, in part, because the futures SROs have exercised less authority over members than the securities SROS.  These differences are diminishing as the CFTC/SRO/member-firm relationship comes to resemble more closely the SEC/SRO/member-firm relationship.  Accordingly, this may be a good time to examine some basic questions and assumptions, such as (i) to what extent can the CFTC properly exercise authority over member firms through the futures SROs and (ii) is there a point at which the futures SROs effectively become agents of the government?

See:  NFA Letter to the CFTC.


MFA Submits Supplemental Letter to SEC on Tri-Party Segregation Terms

The Managed Funds Association (“MFA”) submitted additional comments to the SEC to supplement two previous MFA letters regarding the proposed imposition of a capital charge on security-based swap dealers (“SBSDs”) when their financial end user counterparties elect to segregate initial margin for uncleared security-based swaps. 

The letter specified that the MFA is writing “to highlight the protections and safeguards afforded both the SBSDs and the pledgors by tri-party segregation arrangements.”  The letter included a list of suggested contractual provisions that would be protective of the SBSD and the pledgor, so as to render unnecessary the imposition of a capital charge on SBSDs when their financial end user counterparties elect to segregate initial margin for uncleared security-based swaps.

Lofchie Comment:  This discussion highlights a fundamental issue:  there is an inevitable tension between protecting customers from dealer risk and protecting dealers (and the market as a whole) from individual customer risk.  That tension cannot be eliminated wholly; the question is whether customers, dealers and the regulators can agree on a middle course that is satisfactory.

Historically, broker-dealer regulation emphasized protecting broker-dealers from individual customer risk by requiring broker-dealers to hold customer collateral under the full control of the broker-dealer.  Permitting tri-party arrangements as to swaps without requiring broker-dealers to take capital charges, even though they are not in full control of the customers’ collateral, would be a policy change, albeit, one that customers will be pushing for in light of increased awareness – post-Lehman that dealer failure creates risk.

See:  MFA Letter to SEC.


SIFMA, SIFMA AMG, and ISDA Submit Comments to CFTC on Proposed Position Limits Rules

In three separate comment letters, SIFMA, the Asset Management Group of SIFMA (“SIFMA AMG”) and ISDA submitted comments to the CFTC on the proposed Position Limits for Derivatives and Aggregation of Position Limits rules (“Proposal”). 

SIFMA and ISDA submitted both a legal analysis of the Position Limits for Derivatives Proposal and comments, stating that they remain “deeply concerned” with many aspects of the Proposal and continue to challenge the fundamental premise on which the CFTC argues that it has authority to impose position limits under Dodd-Frank. The groups stated that they do not believe the CFTC should go forward with the Proposal until it is able to demonstrate that the statutory prerequisites for imposing position limits have been satisfied, and that the CFTC has evaluated the costs and benefits of the rules. 

SIFMA AMG additionally submitted comments regarding the Position Limits for Derivatives Proposal, stating that it recognizes regulatory action may be appropriate under certain circumstances in order to achieve CEA goals for setting position limits, but that it continues to question whether position limits would achieve those goals.  SIFMA AMG explained that the CFTC has not met the statutory requirements of the CEA in proving that speculative position limits are “necessary” and “appropriate,” and that the Proposal should be withdrawn to make the needed findings.

SIFMA AMG also commented on the Aggregation of Position Proposal, stating that it has concerns with certain aspects of the Proposal and making recommendations to areas including (i) owned entity aggregation, (ii) investment in accounts or pools with “substantially identical trading strategies” (iii) passive investors in CFTC Rule 4.13 (“Exemption from Registration as a Commodity Pool Operator”), and (iv) independent account controller exemption. 

Lofchie Comment: The CFTC’s cost-benefit analysis is weak and vulnerable to challenge. The better use of the Commission’s resources would be to undertake a truly independent study of the economics rather than proceed on its current course and adopt a rule likely to be heading to court. A genuinely independent study, in whatever form, could perhaps serve to establish a consensus on a final rule (or the rejection of a rule). At least then, there would be a basis for a decision motivated by policy and not perception.

See: SIFMA and ISDA Letter and Analysis; SIFMA AMG Letter on Position Limits; SIFMA AMG Letter on Aggregation of Positions
Related news: CFTC Issues Proposed Position Limits Rule (Fed. Reg.) (December 13, 2013).


SIFMA and AFME Issue Statement on Transatlantic Financial Regulation Negotiations

SIFMA and the Association for Financial Markets in Europe (“AFME”) issued a joint public statement regarding the Transatlantic Trade and Investment Partnership negotiations, remarking that “expanding opportunities for financial services providers and their clients in the transatlantic market can only be realized if TTIP includes commitments for regulatory coordination and cooperation.” 

The associations further noted that the week’s TTIP meeting offered a critical opportunity to improve the efficiency of regulations across jurisdictions, which each believed would “facilitate and guide efforts to promote consistent high-quality regulatory standards in global markets.”

Lofchie Comment:  That SIFMA and AFME feel a need to issue a joint statement asking negotiators to “enhance coordination, reduce conflict and confusion, and improve the efficiency of regulations across jurisdictions” is itself, a sad commentary.  Consider the policy implications that led to the current predicament in which the U.S. has gone down such an irrational path that a mutual agreement with the European Union is the best hope for preventing further damage to our economy.

See:  SIFMA Press Release (including the joint public statement).


SIFMA AMG Requests Extension of Deadline for Mandatory SEF Execution

The Asset Management Group of SIFMA (“SIFMA AMG”) submitted comments to the CFTC renewing a January 13th request for no-action relief as to the CFTC’s compliance date for mandatory trading on SEFs. 

In response to the CFTC’s request for an explanation as to why SEF trading should not be made mandatory, the trade association listed 17 major issues, some of which were both operational and legal (see pages 2-4 of the letter).

Lofchie Comment:  Craig Pirrong (also known as the Streetwise Professor) describes the mandate for firms to trade on Swap Execution Facilities as the worst provision in Dodd-Frank (see linked article).  Though that is arguable, he does explain why SEF trading adds no protection against systemic risk.  More troubling is the process by which this mandate was adopted.  There may be no provison of Dodd-Frank adopted with such little care for its effect on the market.  The CFTC justified its very low standard for forcing trading onto SEFs by stating that the low standards were intended to ease the cost burden on SEFs.  This justification, however, did not regard the cost burdens on firms that would be required to trade on SEFs, not to mention the impact to the economy as a whole.   The problems that were at all times obvious to knowledgeable market participants are now becoming obvious to all: the rules won’t work and the timetables can’t be met.

Rather than extending the deadline, the CFTC should rethink the entire SEF process.  For the Commission to force interest rate swaps and other swaps that are commonly used for hedging onto automated exchanges, where the rules are moving pieces and the operational processes are moving even faster, seems genuinely imprudent.  What happens if there are material problems?  Who bears responsibility?

See:  Comment Letter.


Enhanced Prudential Standards for Bank Holding Companies and Foreign Banking Organizations

The Board of Governors of the Federal Reserve System (“FRB”) approved final amendments to Regulation YY to implement certain of the enhanced prudential standards required to be established under Dodd-Frank Section 165 (“Enhanced Supervision and Prudential Standards for Nonbank Financial Companies Supervised by the Board of Governors and Certain Bank Holding Companies”).

The enhanced prudential standards include risk-based and leverage capital requirements, liquidity standards, requirements for overall risk management, stress-test requirements, and a 15-to-1 debt-to-equity limit for companies that, the FSOC has determined, pose a grave threat to financial stability.  The final rule strengthens the supervision and regulation of large U.S. bank holding companies and foreign banking organizations with total consolidated assets of $50 billion or more.

The amendments also establish risk committee requirements and capital stress testing requirements for certain bank holding companies and foreign banking organizations with total consolidated assets of $10 billion or more. The rule does not impose enhanced prudential standards on nonbank financial companies designated by the FSOC for supervision by the FRB.

The final regulation extends the initial compliance date for foreign banking organizations to July 1, 2016, a year later than originally proposed.  The final rule generally also defers the application of the leverage ratio to foreign-owned U.S. intermediate holding companies until 2018.

U.S. bank holding companies subject to the rule will need to comply by January 1, 2015.

With respect to foreign banks, the final regulations reflect only a modest relaxation from the initial proposal. The final regulations raise the threshold for mandatory creation of an “intermediate holding company” (IHC) from $$10 billion in nonbranch U.S. assets to $50 billion, delay the leverage capital requirement for IHCs until 2018, and delay the mandatory compliance date for all other requirements until July 1, 2016 (originally, July 1, 2015)).  However, the final regulations require a foreign bank subject to the Section 165 regulations to prepare written implementation plans by January 1, 2015, documenting the foreign bank’s plans for coming into compliance with the Section 165 regulations.  This implementation planning process is, of course, in addition to the conformance planning process required under the Volcker Rule, which goes into effect on July 21, 2015.

See:  FRB Press Release; Text of Final Rule.