Survey Emphasizes Costs of Dodd-Frank on End-Users

The Coalition for Derivatives End-Users published a survey indicating that margin requirements from Dodd-Frank would adversely impact end-users, emphasizing the costs of margin requirements on end-users and the potential negative impact on employment.  The survey provided a quantitative look into companies’ utilization of Over-the-Counter (“OTC”) derivatives, Centralized Treasury Unit (“CTU”) usage, and the effect a margin requirement would have on companies’ abilities to manage business uncertainty.  Additionally, it considers how companies are impacted by new reporting burdens and inconsistencies created by the divergent approaches of the U.S. and EU reporting regimes. 

The survey is the third report conducted on the likely impact of margin and other derivatives regulations; the previous surveys (which are also linked below) were conducted in 2010 and 2011.

The report analyzes the responses of 43 chief financial officers, or corporate treasurers of both public and private companies from a variety of sectors.  According to the survey, companies utilizing derivatives to mitigate business risk may be forced to reduce capital spending, hindering future business investment.

Key survey findings include:

  • an overwhelming majority (86 percent) of companies indicate that government-imposed margin requirements would adversely impact business investment, acquisitions, R&D and job creation;
  • the median respondent would need $125 million to fully collateralize its OTC derivatives transactions;
  • Four out of five respondents say that a margin requirement will impact capital expenditures, with 37 percent noting the impact will be “significant”; and
  • 91 percent say that a margin requirement will alter their risk-mitigating hedging strategies.

Lofchie Comment:  The survey makes clear that regulation of derivatives inflicts costs on the financial sector and burdens the “real” economy. While the results of the survey are consistent with previously expressed views on Dodd-Frank, additional questions may have elicited more balanced information. For example, end-users should be asked whether (i) they believe that Dodd-Frank has made them or their markets safer and (ii) whether they see any improvements in pricing as a result of Dodd-Frank.

A sobering concern raised in the survey is the impact on unemployment. It is important to remember that the 100,000 potentially lost jobs are those resulting from just one provision of Dodd-Frank; e.g., one page in the original 800-page version of the bill. The total job losses could be far larger than that resulting from any single provision of the bill.

See:  The Coalition for Derivatives End-Users Survey: “The Impact of Margin Requirements on Main Street Businesses.”
See also:  An Analysis of the Coalition for Derivatives End-Users’ Survey on Over-the-Counter Derivatives (February 11, 2011); An Analysis of the Business Roundtable’s Survey on Over-the-Counter Derivatives (April 14, 2010).


SEC Commissioner Gallagher Discusses Shareholder Proposals and the Federalization of Corporate Governance

At the 26th Annual Corporate Law Institute at Tulane University, SEC Commissioner Daniel Gallagher spoke about the “federalization of corporate governance” and argued that the SEC should take a lesser role in shareholder proposals.   

According to Commissioner Gallagher, the trend toward increased federalization of corporate governance law seems well entrenched, since Dodd-Frank has mandated an array of federal regulations relating to matters traditionally left to state corporate governance law. 

One area where Commissioner Gallagher believes the SEC’s incursions have had a particularly negative effect is shareholder proposals.  According to Commissioner Gallagher, while the conduct of the annual shareholder meeting is generally governed by state law, the process of communicating with shareholders to solicit proxies for voting at that meeting is regulated by the SEC. 

However, the Commissioner stated that the SEC has never adequately addressed the costs and benefits of this process, noting that a proponent can currently bring in a shareholder proposal if he or she has owned $2,000 or 1% of the company’s stock for one year, so long as the proposal complies with a handful of requirements.  Commissioner Gallagher stated that “activist investors and corporate gadflies have used these loose rules to hijack the shareholder proposal system,” and that the majority of shareholder proposals “are brought by individuals or institutions with idiosyncratic and often political agendas that are often unrelated to, or in conflict with, the interests of other shareholders.”  According to Commissioner Gallagher, only 1% of proposals are brought about by ordinary institutional investors. 

Commissioner Gallagher said that, while he isn’t sure whether shareholder proposals are needed at all, the SEC’s rules should be remedied nonetheless to prevent activist investors from crowding out institutional investors.  His suggestions included:

  • updating the holding requirement to submit proxies from the flat dollar test of $2,000 to a percentage test, which he believes is scalable and varies less over time (the Commissioner stated that rigorous analysis must be applied to determine what percentage is an appropriate default); 
  • reassessing the length of the holding requirement, since a longer investment period could help prevent some activists from buying into a company solely for the purpose of bringing a proposal;
  • setting the requirements as to the substance of proposals in order to avoid proposals with dubious “significant policy issues”;
  • reassessing the rule that permits the exclusion of proposals that are contrary to the SEC’s proxy rules, including proposals that are materially false and misleading or that are overly vague, since the “burden to ensure that a submission is clear and accurate should be placed on the proponent, not the company”; and
  • strengthening the resubmission thresholds and possibly adopting a policy that excludes for the following five years a proposal which fails in its third year to garner majority support. 

Lofchie Comment:  Dodd-Frank contains a number of ill-considered requirements for how firms must structure their internal operations, including that the Chief Compliance Office responsible for compliance with the U.S. Commodity Exchange Act must report directly to the Board of Directors of the relevant institution.  Consider the case of a major non-U.S. bank, which may operate in 20 or more countries and must comply with dozens or hundreds of laws in each of those countries.  That the compliance officer responsible for one U.S. statute must report directly to the Board when, in the ordinary course of events, that compliance officer would be several levels below the Board in the corporate hierarchy, is ultimately a waste of time and a drain on corporate resources, as firms must figure out how to comply with a completely arbitrary governance requirement.  Shouldn’t it be sufficient that swap dealers are obligated to comply with the law?  Why is it also necessary to dictate which individuals must report directly to a firm’s Board?

See: Commissioner Gallagher’s Speech.


CFTC Announces Public Roundtable to Discuss Dodd-Frank End-User Issues

The CFTC will hold a public roundtable on April 3, 2014, to discuss issues concerning end users and the Dodd-Frank Act.

The roundtable will consist of three panels discussing:

  • the obligations of end users under CFTC Rule 1.35 (“Records of Commodity, Interest and Related Cash or Forward Transactions”) concerning recordkeeping for commodity interest and related cash or forward transactions;
  • the appropriate regulatory treatment of forward contracts with embedded volumetric optionality; and
  • the appropriate regulatory treatment for purposes of the $25 million (special entity) de minimis threshold for swap dealing to government-owned electric utilities.

See: CFTC Announcement.


CFTC Publishes Request for Comment on Swap Data Recordkeeping and Reporting Requirements (Fed. Reg.)

The CFTC published in the Federal Register its request for comment regarding swap data recordkeeping and reporting requirements.  The request for comment was developed by the newly created CFTC interdivisional staff working group, which is reviewing CFTC swap data reporting rules to make recommendations, resolve reporting challenges and consider data field standardization and consistency in reporting by market participants. 

The interdivisional working group – which includes staff from the Division of Market Oversight, the Division of Clearing and Risk, the Division of Swap Dealer and Intermediary Oversight, the Division of Enforcement, the Office of the Chief Economist, the Office of Data and Technology, and the Office of General Counsel – is seeking comments to help determine how swap data reporting and recordkeeping rules are being applied and to determine what clarifications, enhancements or guidance may be appropriate.

The request for comment is limited to Part 45 (“Swap Data Recordkeeping and Reporting Requirements”) and related provisions. Comments must be submitted by May 27, 2014. 

See:  79 FR 16689.
Related news:  CFTC Announces It Is Requesting Public Comment on Swap Data Reporting Rules (Pre-Fed. Reg.) (March 20, 2014); CFTC Announces Formation of Interdivisional Working Group to Review Regulatory Reporting (January 22, 2014).


CFTC Publishes Interim Final Rule and Request for Comment Regarding Access to SDR Data (Fed. Reg.)

The CFTC published in the Federal Register its interim final rule and request for comment regarding access to swap data repository (“SDR”) data by market participants. 

The interim final rule clarifies that, for a swap which is executed anonymously on a swap execution facility or designated contract market, and which is then cleared in accordance with the CFTC’s straight-through processing requirements, the data and information maintained by a registered SDR that may be accessed by either counterparty to the swap does not include information as to the other counterparty or the other counterparty’s clearing firm.

The interim final rule is effective March 26, 2014.  Comments must be submitted by April 25, 2014. 

See:  79 FR 16672.
Related news:  CFTC Publishes Guidance, No-Action Letter and Interim Final Rule to Promote Trading on SEFs and Support an Orderly Transition to Mandatory Trading (CFTC Letter 14-12) (February 11, 2014).


IRS Provides Guidance on the Taxation of Bitcoin and Other Virtual Currency

The IRS has announced that it will treat Bitcoin and other virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, as property for tax purposes and not foreign currency.  As a result, the general principals that apply to property transactions also apply to virtual currency.  Thus, taxpayers could claim capital gains and losses on Bitcoin that the taxpayer used to acquire other property or pay for services.

In Notice 2014-21 (linked below), the IRS addresses 16 “frequently asked questions” on the taxation of virtual currency.  For example, a taxpayer who receives virtual currency as payment for goods or services must include in his gross income the fair market value of the virtual currency, measured in U.S. dollars as of the date the virtual currency was received.  A taxpayer that uses Bitcoin or other virtual currency to purchase property or to pay for services can also recognize taxable gain or loss on the transaction.  If, for example, the fair market value of the property received by a taxpayer in exchange for virtual currency exceeds the taxpayer’s tax basis in the virtual currency, the taxpayer will have a capital gain, as long as the virtual currency was a capital asset in the hands of the taxpayer.  If the fair market value of the property received in exchange for the virtual currency is less than his basis in such virtual currency, the taxpayer will have a loss; however, the deductibility of capital losses in excess of capital gains is limited.

The notice makes it clear that virtual currency is not treated as foreign currency that could generate foreign currency ordinary gain or loss under Section 988 of the Internal Revenue Code.  According to the notice, virtual currency used to pay for services of an employee constitutes wages for employment tax purposes and thus the fair market value of such virtual currency is subject to income tax withholding and FICA and FUTA taxes, and must be reported on Form W-2.  Virtual currency used to pay independent contractors must be reported on Form 1099-MISC and payments of virtual currency are also subject to backup reporting.  A taxpayer who “mines” virtual currency is subject to tax on the amount received.

The notice takes effect immediately and covers past and future transactions and tax returns.  However, in the notice, the IRS suggested that it might offer relief from penalties to taxpayers who engaged in virtual currency transactions before March 25, 2014, and can show “reasonable cause” for any underpayments of tax.

See:  Notice 2014-21.


SEC Publishes Proposed Rules for Systemically Important and Security-Based Swap Clearing Agencies (Fed. Reg.)

The SEC published in the Federal Register its proposed rules that would enhance the oversight of clearing agencies that are deemed to be systemically important by the Financial Stability Oversight Council (“FSOC”) or that are involved in complex transactions, such as security-based swaps (“covered clearing agencies”).

The covered clearing agencies would be subject to new and “more robust” requirements regarding their financial risk management, operations, governance and disclosures to market participants and the public.  The proposal also would establish procedures for the SEC to use to apply the new requirements to additional clearing agencies.

Comments regarding the proposed rule must be submitted by May 27, 2014.

See:  79 FR 16866.
Related news:  SEC Proposes Rules for Systemically Important and Security-Based Swap Clearing Agencies (March 12, 2014).


Australian, Hong Kong, and Malaysian Financial Stability Reports Released

The Reserve Bank of Australia, Hong Kong Monetary Authority, and Bank Negara Malaysia recently released financial stability reports. See:

  • Reserve Bank of Australia Financial Stability Review
  • Hong Kong Monetary Authority March 2014 Half-Yearly Monetary and Financial Stability Report.
  • Bank Negara Malaysia 2013 Financial Stability and Payment Systems Report
  • For more on financial stability, including country reports, work from regulatory bodies, and studies from the IMF and BIS, see here.

    CFTC Commissioner O’Malia Delivers Speech Discussing Technology and the Future of Financial Standards

    CFTC Commissioner Scott O’Malia delivered the keynote address at the SWIFT Institute’s Future of Financial Standards Forum in which he discussed how to transform regulatory oversight both domestically and internationally through technological innovation. 

    Commissioner O’Malia addressed the future of financial standards, specifically stating that developing technology and data standards can “increase efficiency and reduce costs for not only the industry, but also regulators.”  Pointing to SWIFT’s success in using technology and data standards to evolve and keep pace with technological innovations and developments, Commissioner O’Malia stated that the CFTC, too, must adopt and build new technologies and analytics to become a 21st-century regulator.

    To do this, and to “efficiently and cost-effectively surveil the markets to meet Dodd-Frank mandates,” Commissioner O’Malia noted, the CFTC should make immediate internal technological improvements in three critical areas:

    • swaps data quality: the Commissioner stated that, although it has been a year since swap data reporting began in the United States, the CFTC is still unable to crunch the data in swap data repositories (“SDRs”);
    • additional automated surveillance tools: according to Commissioner O’Malia, the CFTC does not presently have a database that links the futures and swaps market to aggregate and perform cross-market analytics, horizontal reviews, or surveillance for systemic risk, and developing such a database is vital to understanding the behavior of automated trading systems and identifying suspicious activity; and
    • automated risk analytics: Commissioner O’Malia stated that the CFTC must implement a strategy to integrate swaps, futures and options data to perform risk analysis and surveillance. 

    Beyond these areas, Commissioner O’Malia stated, immediate attention also must be focused on SDR data harmonization efforts.  O’Malia provided principles to guide the CFTC’s efforts to improve data quality, including: (i) requiring that all filings be submitted electronically and in a consistent mode and manner, (ii) conforming the data requested on mandated forms to the standards currently utilized by entities to minimize compliance costs and confusion, and (iii) better quantifying the cost of reporting burdens and additional costs of requiring different data streams across various rules.

    Additionally, on an international level, Commissioner O’Malia mentioned that, during a recent visit to Brussels, he requested that the U.S. and EU engage in an immediate discussion to recognize each other’s swap trade repositories and develop the means to share data, as well as collaborate to harmonize both the form and format of reported data.  According to O’Malia, this mutual recognition of SDRs and trade repositories (“TRs”) is critical to the analysis and monitoring of threats to financial stability and would eliminate duplicative reporting.  Commissioner O’Malia also stated that he hopes the U.S. and EU use recent works to supplement and guide the coordination of swap data standards, such as the Committee on Payment and Settlement System (“CPSS”) and IOSCO final report on OTC derivatives data reporting and aggregation requirements, as well as the Financial Stability Board (“FSB”) consultation paper on the aggregation of OTC derivatives data.

    Additionally, Commissioner O’Malia noted the recent international progress in creating universal identifiers, stating that international regulators are “well on their way” to putting global Legal Entity Identifiers (“LEIs”) into place, and that discussions are underway regarding the feasibility of a standard for the structure of a global unique transaction identifier (“UTI”).  Finally, O’Malia stated that the CFTC held a kick-off meeting for a cross-divisional working group to assess swap product identification and associated product taxonomy/unique product identifiers (“UPIs”), and added that the CFTC is developing technical principles and a governance model that will help guide the framework and operational elements for future taxonomy maintenance.

    Lofchie Comment:  CFTC Commissioner O’Malia is ahead of the curve among regulators calling for a much more systematic and disciplined approach to the collection of information by the CFTC and, implicitly, by other regulators.  His persistent demand for reexamination of the CFTC’s recordkeeping and reporting requirements very clearly led to the CFTC’s recent decision to reexamine its Part 45 Rules. Further, his insistence that U.S. and European regulators should coordinate their requirements is critical going forward.

    That said, U.S. and European regulators aren’t the only ones who must do a better job at coordination.  The various U.S. regulators (the SEC, the CFTC, the NFA, FINRA, the various exchanges, the banking regulators, and everyone with respect to the Volcker Rules) are simply overwhelming the financial industry and, indeed, the economy with onerous recordkeeping and reporting requirements, which yield large amounts of information that is either useless or unusable.  There ought to be some way for the U.S. financial regulators to come to an agreement as to what information is actually required and in what format, and as to establishing priorities.

    One might expect that the new Office of Financial Research established by Dodd-Frank would be a logical center from which to establish a consensus as to the government’s information requirements.  However, given that the OFR is understood to be the agency largely responsible for the draft of Form PF (information required to be collected from private funds), expectations must be tempered.  Form PF is generally regarded as an ill-considered and utterly wasteful information collection exercise.  There must be a better place to turn.

    See:  Commissioner O’Malia’s Speech
    See also:  CFTC Announces It Is Requesting Public Comment on Swap Data Reporting Rules (Pre-Fed. Reg.) (March 20, 2014).