Parties Submit Supplemental Briefs in SIFMA v. CFTC Cross-Border Guidance Case

In response to the June 23, 2014 order from the U.S. District Court for the District of Columbia (the “Court”), the CFTC, as well as SIFMA, ISDA and the Institute of International Bankers (the “Associations”), submitted supplemental briefs to the Court regarding (i) shareholder standing and (ii) interpretive rules in the lawsuit against the CFTC’s Cross-Border Guidance.  

According to the Associations’ supplemental brief, an association has standing to challenge government action “when at least one of its members has standing, the interests it seeks to protect are germane to the organization’s purpose, and the participation of its individual members in the suit is not otherwise required.”  The Associations stated that they have standing in the Cross-Border Guidance Case, and that they can challenge the CFTC Cross-Border Rule because “their formally enrolled members and their represented affiliates could do so individually.”

By contrast, the CFTC’s supplemental brief asserted that, when the Associations disclosed the names of members allegedly injured by the Cross-Border Guidance after originally claiming that standing was “self-evident,” the employees came from two types of entities: (i) U.S.-based conglomerates, such as JPMorgan, Goldman Sachs and Morgan Stanley; and (ii) conglomerates based overseas, such as Société Générale and Deutsche Bank.  The CFTC asserted that none of the relationships of the employees in these entities conferred standing.

Furthermore, the Associations’ supplemental brief explained, the Cross-Border Rule cannot be sustained as an interpretive rule because the CFTC labeled the Cross-Border Rule as a policy statement and it is plainly legislative rather than interpretative.  According to the Associations, it is “absurd for the CFTC to contend that regulated entities will not consider themselves bound by interpretations that – in enforcement actions – federal courts will feel obligated to apply.”  The Associations went on to say that, in any event, “treating it as interpretive would not cure the CFTC’s procedural errors.”

In the CFTC supplemental brief, the CFTC explained that the Cross-Border Guidance is “best classified as a general statement of policy,” but that certain of its statements also could be classified as interpretive rules.  The CFTC stated that, regardless of classification, the Cross-Border Guidance is not final agency action or otherwise reviewable, and classifying it as interpretative would not change the conclusion that the cost-benefit requirement is inapplicable.

The CFTC also submitted a second notice of supplemental authority to bring to the Court’s attention the July 11, 2014 decision in National Mining Association v. McCarthy (“Decision”), during which the U.S. Court of Appeals for the District of Columbia Circuit reversed a decision that the Associations relied upon in their argument regarding the standard for distinguishing non-reviewable policy statements from reviewable legislative rules.  The CFTC stated that the analysis of this Decision strongly supports its position in the Cross-Border Guidance Case, since it reiterates that established law and general statements of policy are not subject to pre-enforcement judicial review under the Administrative Procedure Act.  Additionally, the CFTC stated that the Decision concludes that “the most important factor” in determining whether an agency action is a policy statement or legislative rule “concerns the legal effect (or lack thereof) of the agency action in question on regulated entities.”  The CFTC explained that the Associations have identified no legal effect of the Cross-Border Guidance.

Lofchie Comment:  Whatever one believes about the quality of the policy informing the CFTC’s Guidance, the process (or absence thereof) should be regarded as unacceptable.  Government agencies diminish the moral force of government regulation when they seem to circumvent the procedures by which government agencies are “required” to act.  Further, one cannot argue that the CFTC was “forced” into a procedural end-around by its inability to adopt rulemaking over the resistance of dissidents.  Given the rules of the CFTC, former Chair Gensler was part of the majority during his entire tenure at the CFTC and was entirely able to obtain the votes necessary to adopt his desired measures, but he should not have been able to do so without the checks afforded by public comment and cost-benefit analysis. 

See: The Associations Supplemental Brief; CFTC Supplemental Brief; CFTC Second Notice of Supplemental Authority.
See also: National Mining Association v. McCarthy.


NY DFS Releases Proposed Licensing and Regulatory Framework for Virtual Currency Firms

The New York Department of Financial Services (“DFS”) released a draft proposal for licensing and regulating virtual currency businesses like Bitcoin.  The proposed “BitLicense” regulatory framework contains consumer protection, anti-money laundering compliance, and cybersecurity rules tailored for virtual currency firms.

The new DFS BitLicenses would be required for firms engaged in virtual currency businesses including:

  • receiving or transmitting virtual currency on behalf of consumers;
  • securing, storing, or maintaining custody or control of such virtual currency on the behalf of customers;
  • performing retail conversion services, including the conversion or exchange of fiat currency or other value into virtual currency, the conversion or exchange of virtual currency into fiat currency or other value, or the conversion or exchange of one form of virtual currency into another form of virtual currency;
  • buying and selling virtual currency as a customer business (as distinct from personal use); or
  • controlling, administering, or issuing a virtual currency.

See:  NY DFS Proposed Regulations; NY DFS Press Release.


OCC Proposes Schedule Shift and Adjustments to Regulatory Capital Projections

The Office of the Comptroller of the Currency (“OCC”) issued a proposed regulation that would adjust the timing of the annual stress testing cycle and clarify the method used to calculate regulatory capital in the stress tests.  The proposed regulation also provides that covered institutions will not have to calculate their regulatory capital requirements using the advanced approaches capital methodology in its stress testing projections until the stress testing cycle beginning on January 1, 2016.

Comments are due by July 24, 2014. 

See:  OCC Press Release; 79 FR 37231.


CFTC Files Supplemental Declaration in CFTC Cross-Border Guidance Case

The CFTC filed a motion to submit the supplemental declaration of CFTC Assistant General Counsel Martin B. White (the “declaration”) and two additional documents that, in the words of the CFTC, contradict “the positions SIFMA and other Plaintiffs have taken on key legal points in this case.”  Specifically, the two exhibits filed include (i) a document titled “Note Regarding Non-U.S. Affiliate Participation in Swaps Market” (“SIFMA’s Note”), and (ii) a copy of an article published by POLITICO Pro titled “Banks Outline Pushback on Swap Guarantee Worries.”

According to the declaration, SIFMA’s Note states that Congress “set standards” for cross-border swaps regulation, which contradicts the claims of SIFMA, ISDA and the Institution of International Bankers (“Associations”) in the Cross-Border Guidance case.  Additionally, the CFTC stated, SIFMA’s Note concedes that the Cross-Border Guidance is “guidance,” which differs from the Associations’ claim that the Cross-Border Guidance “is a rule in disguise that extends the Title VII Rules overseas.”  

The CFTC also claimed that the apparent purpose of SIFMA’s Note is to suggest to its members a public explanation for a new business practice, in which U.S. parents of overseas affiliates remove guarantees from swaps with foreign counterparties.  The CFTC stated that this indicates that the Associations’ claim to injury from the Cross-Border Guidance may not be true.

See: CFTC Motion to File Supplemental Declaration; Martin White’s Supplemental Declaration (with SIFMA Note and POLITICO Pro Article).
Related news: Court Requests Supplemental Briefs from Parties in SIFMA v. CFTC Cross-Border Guidance Case (June 25, 2014); 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).


Secretary Lew Discusses Cybersecurity

In his remarks at the 2014 Delivering Alpha Conference, Secretary of the Treasury Jacob Lew called for legislation to enhance defenses against cybersecurity threats. 

According to Secretary Lew, the consequences of cyber attacks are more serious than ever, and financial institutions should be proactive to prevent damage. He stated that, despite their hesitancy to reveal information about security breaches, firms should consider disclosing cyber incidents and collaborate with government agencies and other firms in order to strengthen defenses against cyber attacks. He called for legislation that would encourage information sharing between the government and the private sector. 

See: Secretary Lew’s Speech; SIFMA Statement on Secretary Lew’s Speech


Trade Associations Submit Letters to ESAs on EMIR Risk Mitigation Regulatory Technical Standards

The Managed Funds Association (“MFA”), SIFMA and ISDA sent separate comment letters to the European Supervisory Authorities (“ESAs”) on their joint consultation paper, titled “Draft Regulatory Technical Standards on Risk-Mitigation Techniques for OTC-Derivative Contracts Not Cleared by a CCP” (“Consultation Paper”), regarding EMIR (“European Market Infrastructure Regulation”).

The MFA’s letter voiced support for the ESAs’ efforts to reduce counterparty credit risk and mitigate the potential for systemic risk resulting from uncleared OTC derivative markets. The MFA emphasized the need to ensure that the final regulatory technical standards (“RTS”) outlined in the Consultation Paper are consistent with mandatory margin requirements in other jurisdictions.

Additionally, SIFMA and ISDA submitted a joint comment letter regarding the Consultation Paper. The letter identifies areas of the draft RTS where additional rulemaking and clarification is needed, focusing on subjects including:

  • that the mandatory capture of main nonlinear dependencies and certain other model requirements are overly rigid and prescriptive;
  • the restrictive nature of the proposed concentration limits;
  • that an 8% FX haircut on mismatched collateral would create operational, credit and settlement risk;
  • a two-year implementation window to comply with margin requirements; and
  • consistent margin rules across major financial jurisdictions.

See: MFA Comment Letter; SIFMA-ISDA Comment Letter.


FDIC Issues Notice of Proposed Rulemaking Regarding Revised Risk-Based Deposit Insurance Assessment System

The Federal Deposit Insurance Corporation (“FDIC”) approved a notice of proposed rulemaking (“NPR”) that revises the risk-based deposit insurance assessment system to reflect changes in the regulatory capital rules that will go into effect in 2015 and 2018. 

The NPR would: (i) revise the ratios and ratio thresholds relating to capital evaluations, (ii) revise the assessment base calculation for custodial banks to conform to the new asset risk weights using the standardized approach in the regulatory capital rules, and (iii) require all highly complex institutions to measure counterparty exposure for assessment purposes using the standardized approach in the regulatory capital rules.

The FDIC proposed two effective dates: January 1, 2014, for the revised ratios and ratio thresholds relating to capital evaluations, and January 1, 2018, for the proposed rules regarding revisions to the base calculation for custodial banks and the requirement for all highly complex institutions to measure counterparty exposure.

See: Notice of Proposed Rulemaking.


SEC Commissioner Piwowar Comments on the FSOC

At the AEI Conference on Financial Stability, SEC Commissioner Michael S. Piwowar gave a speech in which he spoke very critically about the accountability and transparency of the Financial Stability Oversight Council (“FSOC,” or the “Council”).

Commissioner Piwowar stated that he is fully supportive of Congressman Garret’s bill, the FSOC Transparency and Accountability Act (H.R. 4387), which Commissioner Piwowar noted has already forced FSOC to begin to clarify its transparency policy. However, Commissioner Piwowar said, he still has many issues with FSOC’s lack of clarity. 

Referring to FSOC as the “Unaccountable Capital Markets Death Panel,” Commissioner Piwowar explained that he had “far too many concerns about the Council to touch on all of them” in his allotted time. He focused his concerns on (i) the role of prudential regulators, especially the Board of Governors of the Federal Reserve System (“FRB”), and (ii) FSOC’s “apparent disdain for non-banking subject matter expertise.”

According to Commissioner Piwowar, prudential regulators have four voting representatives on FSOC, whereas nonbank regulators each have one. Additionally, Commissioner Piwowar explained, the FRB has expanded the prudential regulators’ seats from four to six, and Governor Tarullo recently suggested broadening “the perimeter of prudential regulation” even further. Commissioner Piwowar stated that Governor Tarullo is asserting the FRB’s authority over capital market actors through FSOC and, subsequently, is overlooking the expertise and capability of the SEC’s rulemaking divisions. According to Commissioner Piwowar, “deference is not a word in the Council’s vocabulary.”

Commissioner Piwowar also explained that the SEC’s trading and market expertise is being marginalized by FSOC, since a review of equity market structure should be led by the SEC. He encouraged FSOC and the FRB to submit comment letters to the SEC on this topic. With FSOC and the FRB inserting themselves into the SEC’s jurisdiction, Commissioner Piwowar said, he worries that the SEC’s mission is being compromised. He explained that he is determined to “defend our jurisdiction from the prudential regulators’ Council-enabled turf war.”

Lofchie Comment: Given the intensity of Commissioner Piwowar’s criticism of FSOC, it seems useful to introduce an alternative view defending FSOC from the Commissioner’s withering critique. Matt Levine, a Bloomberg columnist and former investment banker offers one in his article: “Man Dislikes Unaccountable Capital Markets Death Panel.” Levine’s defense of FSOC is instructive in that it is, in part, based on common misunderstandings of the way that the regulations actually work.

The heart of the FSOC’s defense against the attacks by the SEC Commissioner is midway through the linked article, where there is a list of bullet points, among which is the assertion that “[one should] look at [the SEC’s] capital requirements, they’re a joke. Bear was 42 times levered.” The author’s misunderstanding of the SEC’s capital rules likely is unintentional, but it is significant. The SEC’s capital requirements are, in fact, extremely tough; they are far more restrictive in what they allow as good assets than are the rules imposed by the banking regulators. The 42x leverage ratio to which the author refers is that of the broker-dealer holding company, a kind of entity that the SEC did not – and does not have the authority to regulate. Implicit in the author’s outright mistake, however, is a greater mistake: the notion that the banking regulators take capital regulation seriously, and get it right, while the SEC does not on either score. Here is a link to the FSOC’s own 2011 annual report. It doesn’t support the notion that the banking regulators had it right. Rather, it supports the notion that modesty might be a beneficial attribute for everyone involved. 

More substantively, Levine’s FSOC defense goes on to state that, in its most recent financial reports, in response to capital requirements imposed by the banking regulators, Goldman Sachs had reduced its assets by $56 billion, with much of the reduction seeming to be the result of reducing its client financing activity. He says that most of this reduction in lending in response to regulatory pressure was likely a reduction in low-risk lending transactions. He then concludes by commenting: “You’ll need someone smarter than me to tell you why low-risk, low-return, client-financing businesses are the ones that the Fed wants to cut back on, but here we are. I guess it’s reasonable to say that super-leveraging mostly safe things is a big source of risk.” Unfortunately for Mr. Levine, his conclusion undermines the entire point of his FSOC defense because the key economic question is, in fact, “why low-risk, low-return, client-financing businesses are the ones the Fed wants to cut back on.” The author’s defense of the Fed’s position reflects his admitted lack of understanding of the economic substance: “I guess it’s reasonable. . . . “

The main point of SEC Commissioner Piwowar’s remarks is contained in the question: wouldn’t the decision-making process of FSOC be improved if its rules provided a greater opportunity for the expression of differing points of view, including those from regulators who have significant experience overseeing the customer financing markets in question? Questions of process and of jurisdiction are important; they ultimately affect the quality of decision-making. If the process is weak, or is structured in a way to avoid challenges or to exclude those with more expertise, it is less likely to lead to good outcomes. 

Leaving aside the tone of the arguments, and the questions of regulatory jurisdiction that Mr. Levine finds “like, meta-boring,” there is an economic point at issue here, and one that should be opened up for much broader discussion by regulators and economists: are the new banking regulator capital rules unduly harsh on “low-risk, low-return client financing businesses”? If they are, then it’s bad for the economy. 

See: Commissioner Piwowar’s Speech
Related news: House Financial Services Committee Schedules Markup of FSOC Bills (June 18, 2014); House Financial Services Committee Hearing: “Examining the Dangers of the FSOC’s Designation Process and Its Impact on the U.S. Financial System” (May 22, 2014); House Financial Services Committee Chairman Calls on FSOC to Cease and Desist (May 21, 2014); House Financial Services Subcommittee Chairmen Send Letter to FSB and FSOC Requesting Information on Methodologies Used to Designate G-SIFIs (May 12, 2014); House Financial Services Committee Chairman Hensarling Urges Secretary Lew to Cease Using “Too Big to Fail” Designations (May 9, 2014); Representative Garrett Questions the SIFI Designation Authority Granted to FSOC by Dodd-Frank (May 6, 2014); House Subcommittee Chair Garrett Delivers Opening Remarks at Oversight of SEC Hearing, Focuses on FSOC and NMS (April 30, 2014); House Financial Services Subcommittee Chairman Introduces Legislation to Reform FSOC (April 4, 2014).


CFTC Commissioner O’Malia Criticizes CFTC Rulemaking, Supports Customer Protection and End User Relief Act and Cross-Border Issues

CFTC Commissioner O’Malia delivered the keynote address at the Quadrilateral Meeting of European and American financial regulators and lawyers. He focused on what he viewed as the problems created by CFTC rulemaking during the tenure of Chairman Gensler.

Commissioner O’Malia asserted that the fundamental principle for reform is that “regulators must do no harm.” He expressed his concern over continuing reports of market fragmentation and the fracturing of liquidity between U.S. and non-U.S. markets as a result of diverging regulatory approaches to the implementation of the G20 principles. In addition to market fragmentation, he said, the existing CFTC regulations are negatively impacting liquidity for end users and making hedging too costly, leading to high prices for commodities.

According to Commissioner O’Malia, effective regulation comes from a balance between protecting market participants and fostering transparent open, competitive and financially sound markets. He explained that the CFTC must reexamine rules that have negatively affected the market. One example he cited was the definition of “swap dealer.” According to Commissioner O’Malia, the CFTC “failed to faithfully interpret Dodd-Frank by broadly applying the swap dealer definition to all market participants and ignored the expressed statutory mandate to exclude end users from its reach.” Furthermore, Commissioner O’Malia stated, he supports the Customer Protection and End-User Relief Act (H.R. 4413) that was recently passed by the house, stating that it provides important market structure and CFTC reforms that recognize the “real problems” in the markets.

Commissioner O’Malia went on to explain that a holistic approach, which includes substituted compliance and mutual recognition, is essential to a successful cross-border regulatory policy. Commissioner O’Malia stated that he hopes the European Commission will continue to work with the CFTC to find the U.S. regulatory regime equivalent under the European Market Infrastructure Regulation so that the European Securities Market Authority may proceed with the recognition of U.S. central counterparty clearinghouses by the December 15, 2014 deadline under the Capital Requirements Directive (“CRD IV”). Commissioner O’Malia also identified international data sharing and harmonization as another area where mutual cooperation is critical.

Finally, Commissioner O’Malia touched on the technology problems that have plagued the CFTC. He explained that inadequate support for technology has left the CFTC with a “diminished automated surveillance capacity and an inability to manage the regulatory data stored in SDRs.” Commissioner O’Malia called on the CFTC to make serious data technology investments in order to establish automated surveillance as the foundation of the CFTC’s oversight and compliance program. 

Lofchie Comment: Consistent with Commissioner O’Malia’s “fundamental principle of reform” to do no harm, there should be a review of regulations (not only those adopted by the CFTC) that require the reporting of information which the relevant regulator has no ability to store or analyze. It would be useful if an impartial organization, such as the GAO, would conduct a study of the ability of the various financial regulators to make productive use of the various types of information they require to be delivered to them.

See: Commissioner O’Malia’s Speech.
Related news: House Votes to Reauthorize the CFTC, but with New Obligations as to Its Exercise of Authority (providing a description of HR 4413) (June 25, 2014).


House Financial Services Committee Holds Hearing: ”Legislation to Reform the Federal Reserve on Its 100-Year Anniversary”

The House Financial Services Committee held a hearing, titled “Legislation to Reform the Federal Reserve on Its 100-year Anniversary,” to discuss, among other things, the Federal Reserve Accountability and Transparency Act (H.R. 5018).

The following witnesses testified:

See: Committee Memorandum; Archived Webcast.