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.

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).