IOSCO Issues Report on Risk Identification and Assessment Methodologies

IOSCO published a report titled, “Risk Identification and Assessment Methodologies for Securities Regulators,” which provides an overview of the methods, approaches, and tools that IOSCO and securities regulators have developed and implemented to identify and assess emerging and potential systemic risks. 

The report was prepared as part of the IOSCO Committee on Emerging Risks’ effort to identify, analyze, and monitor systemic risk.  The paper is organized around the following themes:

  • the definition of risk;
  • IOSCO risk identification methods;
  • risk identification methods used by securities regulators; and
  • an analytical framework for assessing systemic risks. 

According to the paper, securities regulators are increasingly pairing qualitative risk analysis with quantitative tools, such as risk dashboards that systemically track quantitative risk indicators and data analytics, econometrics, and research. 

See: Risk Identification and Assessment Methodologies for Securities Regulators.


FRB Announces Availability of Data on Systemic Risk Profiles of Bank Holding Companies

The Board of Governors of the Federal Reserve System (“FRB”) announced the availability of data that can be used to evaluate the individual systemic footprint of 33 large U.S. bank holding companies. 

The data covers five categories that are often used to consider the potential systemic risk of a banking organization: size, interconnectedness, complexity, substitutability and cross-jurisdictional activity. 

The information, based on data from the previous calendar year, will be published annually.  To access the data for 2013, search for an individual holding company on the National Information Center website, recall its regulatory reporting forms and download the Banking Organization Systemic Risk Report (FR Y-15). 

See: FRB Press Release; National Information Center


SEC Issues Order Directing FINRA and Exchanges to Develop Tick Size Pilot Program

The SEC issued an order directing FINRA, BATS Exchange, BATS Y-Exchange, the Chicago Stock Exchange, EDGA Exchange, EDGX Exchange, the Nasdaq Stock Market Inc., Nasdaq OMX BX, Nasdaq OMX Phlx, the National Stock Exchange, the New York Stock Exchange, NYSE Arca, and NYSE MKT (collectively referred to as the “Exchanges”) to jointly develop and file a national market system plan to implement a pilot program (“Pilot Program”). 

The Pilot Program would, among other things, widen the quoting and trading increments for certain small cap stocks, with one test group incorporating a “trade-at” requirement.  The SEC intends the pilot program to provide a means of gathering information about the impact of decimalization on the liquidity and trading of the securities of small cap companies, and to test whether a wider tick benefits smaller companies.

If approved, the Pilot Program would be applied uniformly across U.S. markets and the exchanges for a one-year trial period. 

Lofchie Comment:  This pilot program is billed as a test of tick size. An interesting result of the study will be the portion that focuses on the “trade at” test; i.e., that a “trading center” generally cannot execute a trade except at a better price than that which is displayed on a public exchange. According to the release, this requirement is intended to prevent order flow from going to dark pools. However, the real effect of the test may be felt by market makers that internalize retail order flow. In this regard, note that the term “trading center,” includes not only exchanges and dark pools, but also “any . . . broker or dealer that executes orders internally by trading as principal or crossing orders as agent.”

Leaving aside the question of what variables are being tested here, it is good that the SEC is running pilot programs with a view to examining Reg. NMS. In this vein, the SEC might want to consider scoping out a full set of pilot programs around different aspects of Reg. NMS. 

See: SEC Order; Annex A and Annex B.


House Financial Services Committee and Senate Banking Committee Hold Separate Hearings on Annual Report of FSOC

In separate hearings, the House Financial Services Committee and the Senate Banking Committee met to review the 2014 Annual Report to Congress of the Financial Stability Oversight Council (“FSOC”). 

At both hearings, Secretary of the Treasury Jacob L. Lew was the sole witness.

See: House Financial Services Committee Memorandum of Hearing; Archived Webcast of the Hearing; FSOC 2014 Annual Report
See also: Secretary Lew’s Testimony.


FIA Issues Special Report: “Defining High Frequency Trading”

The Futures Industry Association (“FIA”) released its’ sixth report in a series covering the specific areas of the European Securities and Markets Authority’s (“ESMA”) consultation process for the implementation of the Markets in Financial Instruments Directive (“MiFID II”) and the Markets in Financial Instruments Regulation (“MiFIR”). The report, titled “Defining High Frequency Trading,” provides an overview of key interpretations relating to high-frequency and algorithmic trading.

See: FIA Report, “Defining High Frequency Trading.”


Court Requests Supplemental Briefs from Parties in SIFMA v. CFTC Cross-Border Guidance Case

The U.S. District Court for the District of Columbia (the “Court”) requested supplemental briefs from SIFMA, ISDA, the Institution of International Bankers (“Associations”) and the CFTC regarding (i) shareholder standing and (ii) interpretive rules in the lawsuit against the CFTC’s Cross-Border Guidance. 

Specifically, the Court and newly assigned Judge Paul Friedman requested that the Associations and the CFTC submit no more than 12 pages in length addressing:

  • whether the “shareholder standing” rule in the Cross-Border Guidance, which states that “[n]o shareholder – not even a sole shareholder – has standing in the usual case to bring suit . . . on a claim that belongs to the corporation,” is jurisdictional, prudential or a manifestation of the Federal Rules of Civil Procedure Rule 17(a)’s real-party-in-interest requirements.  The Court also asked what implications the shareholder standing rule had in this case regarding the elements of the CFTC’s Cross-Border Guidance that, if and when applied, “would seem to directly regulate the plaintiffs’ members’ legally distinct subsidiaries – but no member itself”; and
  • whether the Cross-Border Guidance is an interpretive rule, based on the Court’s articulated standards for distinguishing interpretive rules from policy statements and legislative rules, and what the implications of an interpretive rule might be as to ripeness, cost-benefit requirements and the level of deference to be applied by the Court. 

The Court requested that both parties submit supplemental briefs addressing these issues by July 14, 2014. 

See: Request for Supplemental Briefs
Related news: SIFMA v. CFTC Cross-Border Guidance Case Reassigned to New Judge (June 23, 2014); Judge Grants Amici Motion for Leave to File Brief in Support of CFTC; CFTC Submits Notice of Supplemental Authority in SIFMA v. CFTC Cross-Border Guidance Case (June 18, 2014); Congressional Democrats’ Amicus Brief Sides with CFTC in SIFMA v. CFTC (March 25, 2014); Better Markets Amicus Brief Supports CFTC’s Cross-Border Guidance (March 21, 2014); CFTC Legal Memorandum to Dismiss Challenge to Its Cross-Border Guidance (March 18, 2014); Chamber of Commerce Submits Amicus Brief Regarding Lawsuit against CFTC Cross-Border Rule (February 5, 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).


House Votes to Reauthorize the CFTC, but with New Obligations as to Its Exercise of Authority

The House of Representatives voted to pass H.R. 4413, the Consumer Protection and End User Relief Act, which reauthorizes appropriations to the CFTC through 2018 and directs the CFTC to issue rules governing the cross-border regulation of derivatives transactions.

The bill also:

  • provides materially increased insolvency benefits for customers of failed FCMs, albeit by effectively subordinating all non-customer claims of an FCM to customer claims (section 102);
  • includes new cost-benefit analyses and procedural requirements for the CFTC (section 203);
  • requires the CFTC to submit, every five years, to certain congressional committees a detailed strategic technology plan focused on its acquisition and use of technology (section 207);
  • requires the CFTC to develop and publish with any proposed rule a plan for: (i) when and for how long the proposed rule will be subject to public comment and (ii) a deadline for compliance with the final rule (section 210);
  • instructs the GAO to study whether CFTC resources are sufficient to enable the CFTC to carry out its duties, and to examine prior CFTC expenditures on hardware, software and analytical processes (section 213);
  • requires the CFTC, in determining whether to exempt from designation as a swap dealer an entity that engages in a de minimis quantity of swap dealing, to treat a utility operations-related swap entered into with a utility special entity as if the entity were not a special entity (sections 341-3);
  • requires a new affirmative CFTC rule or regulation in order to amend or reduce the de minimis quantity of swap dealing that is currently set at $8 billion (section 355); 
  • directs the CFTC, in consultation with the SEC (to the extent swap dealers and major swap participants that are banks are permitted by the regulators or the SEC to use approved financial models to calculate minimum capital requirements and minimum initial and variation margin requirements, including the use of non-cash collateral), to permit the use of comparable financial models by swap dealers and major swap participants that are not banks (section 356); and
  • directs the CFTC to go through a formal rulemaking process with respect to its regulation of cross-border swaps transactions and further directs the CFTC largely to defer to the authority of non-U.S. financial regulators of the most significant economic areas with respect to non-U.S. financial institutions based in those jurisdictions (section 359).

The White House issued a Statement of Administration Policy on the bill, stating that it “strongly opposes” the passage of the bill because “it undermines the efficient functioning of the Commodity Futures Trading Commission (CFTC) by imposing a number of organizational and procedural changes and offers no solution to address the persistent inadequacy of the agency’s funding.” 

Lofchie Comment: Despite its opposition, the White House might be very fortunate if the proposed bill passed. The bill undoes some of the legally questionable administrative processes undertaken by the CFTC and addresses the overreach of Chairman Gensler during his term there. These include (i) the aggressive expansion of swaps regulation over commodity options entered into by commercial users; (ii) the lowering of the swap dealer de minimis level to an amount that will likely force small dealers out of the market (thereby worsening the effect of “too-big-to-fail” institutions by further concentrating the big dealers’ position in the market) and (iii) the CFTC’s flouting of formal rulemaking requirements, particularly with respect to cross-border regulation (but certainly not limited to that). If these are not corrected by legislation, it is likely that the courts, or the CFTC itself, will be forced eventually to correct them. Such a correction will be driven either by end users of derivatives, or by non-U.S. regulators who reject the CFTC’s assertion of power as principal regulator over their home country institutions.

There are good reasons why Congressional authorization for funding the CFTC is not forthcoming without these corrections. It is hard to see Congressional consensus developing for funding an agency perceived as having undertaken a massive expansion of power, in likely contravention of the Administrative Procedures Act and with little regard to the practical limits on the agency’s actual competence or resources. The proposed legislation may be the shortest path forward to an authorization and an increase in funding.

See: Summary of H.R. 4413; Final Vote Results.
See also:
White House Statement on 4413; Senator Stabenow’s Statement on Passage of Bill; Floor Statement of Chairman Frank Lucas on H.R. 4413; FIA’s Statement on House Passage.
Related news: House Agriculture Committee Approves Bipartisan Legislation to Reauthorize CFTC (April 10, 2014); House Agriculture Committee Introduces Legislation to Reauthorize CFTC (April 9, 2014).


CFS and FBI Announce Public / Private Cyber Security Partnership

In the last few days, news about cyber-attacks against a major unnamed hedge fund has highlighted the seriousness of this risk to our overall financial system.

To better assess emerging risks and facilitate coordination surrounding cyber security and threats, the Center for Financial Stability (CFS) and the Federal Bureau of Investigation (FBI) are pleased to announce the formation of a public / private partnership for the financial services community.

Meetings will be hosted by the Vulnerabilities Working Group (VWG) at the CFS. The VWG – more broadly – is at the forefront of gauging financial, macroeconomic, geopolitical, technological, and regulatory risks likely to present over the next 3 to 24 months. Specifically, the technology component will focus on topics such as national security threats, threats to financial institutions, future emerging threats, and crisis management techniques.

The group will be led by Leo Taddeo (FBI) and David X Martin (CFS).

Leo Taddeo serves as the Special Agent in Charge of the Special Operations/Cyber Division of the FBI’s New York Field Office. In this role, Mr. Taddeo leads over 400 special agents and professional support personnel in cyber investigations, surveillance operations, information technology support, and crisis management.

David X Martin is an acknowledged expert on risk management. He has served as the founding chairman of the Investment Company Institute’s Risk Committee (ICIRC), and co-chair of the Buy Side Risk Committee, composed of the chief risk officers of the twenty largest asset management firms. He has also published on cyber security. Prior to CFS, David was the chief risk officer at AllianceBernstein.

Aside from excessive central bank liquidity, cyber threats are a meaningful risk to the financial system and could ultimately be part of the next financial crisis.

For more information about this new partnership, please contact LeAnn Yee (manager of communications and development) at

News reports include:

Hedge-Fund Hack Part of Bigger Siege, Cyber-Experts Warn –

CNBC News Story –

CFTC Releases Research Paper on Electronic Markets, Trader Anonymity and Market Fragility

The CFTC released to the public an authorized research paper titled, “Electronic Market Makers, Trader Anonymity and Market Fragility.”  The paper, which was written by third-party professors, analyzes the impact of electronic market-makers on the reliability and the consistency with which financial markets provide transactional liquidity services, based on monitoring intraday position-level data from the WTI Crude Oil futures markets collected from NYMEX between 2006 and 2011. 

Researchers found “strong evidence that electronic market makers reduce their participation and their liquidity provision in periods of significantly high and persistent volatility, in periods of significantly high and persistent customer order imbalances, and in periods of significantly high and persistent bid ask spreads.”

Lofchie Comment:  The study assumes the inevitability that trading by so-called “locals” will disappear or become irrelevant. Put differently, the study does not call for a doomed-to-fail requirement that the markets reverse themselves and go manual. As to its “praise” of locals for staying in markets during volatile times, the study did not provide any understandable information as to whether the locals were able to trade profitably during periods of market volatility, and, if so, how. 

While the study questions whether electronic market makers should be subject to mandatory market-making obligations, it does not suggest that market makers receive any reciprocal benefit. It is unlikely that firms would be willing to become subject to extensive burdens of forced market-making in the absence of receiving a benefit. In fact, one of the defining characteristics of the old NYSE specialist system was that specialists received such a benefit. While there seems to be considerable nostalgia for the willingness of the specialists to limit market volatility, they were generally well rewarded for their willingness and typically earned returns that were viewed as disproportionately high relative to their investment and risk.

See: Electronic Market Makers, Trader Anonymity and Market Fragility.