CFTC Commissioners Deliver Opening Statements at CFTC’s EEMAC Meeting

CFTC Commissioners Sharon Y. Bowen, J. Christopher Giancarlo and Mark Wetjen delivered their opening statements at the second meeting of the CFTC Energy and Environmental Advisory Committee (“EEMAC”). Commissioner Giancarlo began the meeting by highlighting the topics to be covered by the EEMAC.

The first panel considered a framework for the CFTC authorization of the exchanges to grant bona fide hedging exemptions for legitimate risk-reducing strategies. The panel also explored the possibility of exchanges administering a position accountability regime as a way to soften the impact of the declining liquidity of the spot period.

The second panel examined the possibility of adopting a phased federal position limits rule, the initial phase of which would cover the spot month. Commissioner Giancarlo said that this approach would avoid exacerbating the present liquidity problems outside of the spot month that were identified at the last EEMAC meeting.

Finally, the third panel explored trade options and forward contracts with embedded volumetric optionality (“EVOs”). Commissioner Giancarlo noted that the CFTC recently finalized a revised interpretation of the Commission’s seven-part test for EVOs, which provides market participants with certainty on whether their physically settled and often long-term contracts must be treated as swaps. Commissioner Giancarlo assured the Committee that the panel would provide it with an update on the degree to which the CFTC’s recent actions resulted in the intended regulatory certainty.

The Commissioners’ statements shared a common theme: that the CFTC should provide additional relief and clarity with regard to the regulatory treatment of volumetric options, which would allow end users in the energy and agricultural industries to make more productive use of their investments.

Commissioners Bowen and Giancarlo diverged in their views on positions limits. Commissioner Bowen stated that the CFTC should “buckle down and finish the [position limits] rule” rather than reopen the comment period for it yet again. Commissioner Giancarlo, who generally opposes the imposition of broad position limits, stressed that any such rules should be adopted slowly (if at all), beginning with spot month limits.

Lofchie Comment: The argument that Commissioner Bowen makes for not reopening the comment period again is that the comments received by the CFTC during its first reopened comment period were virtually identical to those that it received on the original proposal; thus, nothing would be gained by a second reopening. However, the reason that both sets of comments were so similar is because the CFTC did not take material account of the first set. Since the CFTC left its original proposal largely untouched, and since the CFTC Chair did not seem open to taking comments at the time, there was no reason to expect that the second set of comments would differ from the first. That said, reopening the comment period again would make sense if the CFTC took account of the first two sets of comments and issued a reproposed rule that reflected what it had learned.

Regarding the specifics of position limits, particularly concerning energy, it seems possible that persons who have been advocates of those limits might rethink their advocacy in light of the events of the past several years. Given the various conflicts in the Middle East, the developments in Russia, the sanctions against Iran, the ability of large oil producing countries to withhold or market supply, the growth of fracking and the crash in energy prices, is it plausible that evil speculators are going long on oil derivatives to drive up prices? Because if they were, then they would have been bankrupted by their utter failure, and I am unaware of any such bankruptcies. Doesn’t the reality of that situation do anything to dent the assertion that position limits are a worthwhile form of regulation?

House Hearing Challenges Dodd-Frank’s Success on Its Fifth Anniversary

The House Financial Services Committee (“FSC”) held a hearing titled “The Dodd-Frank Act Five Years Later: Are We More Prosperous?” The hearing examined the Dodd-Frank Act’s implementation, operation and general legislative impact on economic prosperity over the past five years. The following witnesses testified:

See: Webcast of Hearing; Chair Hensarling’s Opening Statement; FSC Press Release; FSC Memorandum.

FINRA Focuses on Seniors, AML and Municipal Advisors in Fourth Podcast on Priorities

FINRA issued the fourth in a six-part series of podcasts about its Regulatory and Examination Priorities for 2015. The fourth podcast discusses FINRA’s sales practice priorities and sets out issues for firms to consider when drafting compliance plans and making compliance decisions.

Senior Investors

  • FINRA noted that many firms have developed specific internal guidelines for strengthening suitability oversight and providing training on the needs of senior investors. FINRA urged firms to review their senior investor procedures and emphasized that protecting senior investors requires more than compliance with FINRA and federal securities regulation.

Anti-Money Laundering

  • FINRA said that it will review firms’ surveillance systems for cash management accounts and determine whether those systems are adequately designed to identify suspicious activity. FINRA stated that some firms have not sufficiently monitored the delivery versus payment and receipt versus payment accounts of foreign financial institutions for suspicious activity or acceptable securities compliance.
  • FINRA stated that firms’ customer trading surveillance should be tailored to the anti-money laundering risks that are inherent in their business liens, products and customer bases. FINRA also noted that examiners must check whether firms have systems to monitor red flags for suspicious customer trading activity.

Municipal Advisors in Securities

  • FINRA said that it will focus on SEC and MSRB municipal advisor requirements for the proper application of exclusions, exemptions and potential unregistered activity. FINRA added that it also will focus on firms that sell municipal bonds for less than the required minimum denomination.

Lofchie Comment: This fourth podcast may be distilled into three issues: (i) the treatment of seniors; (ii) anti-money laundering fines and penalties that have hit firms hardest (in terms of punitive settlements); and (iii) the new regulatory scheme for municipal advisors. It is imperative for firms to attend to these issues.

OCC Comptroller Curry Applauds Work of New England Council, Discusses Risks to the Financial Industry

Comptroller of the Office of the Currency (“OCC”) Thomas J. Curry discussed the importance of the New England Council, remarking that it provides a place for businesses of different sizes and types to work together in the interests of a prosperous regional and national economy. His speech highlighted challenges businesses face, including: (i) the “near certainty” of rising interest rates and how they could imperil loan quality; (ii) the impact of new and tougher regulatory compliance, such as Dodd-Frank; (iii) resulting growing costs of regulation, and (iv) constant cyber threats.

Lofchie Comment: Notably, a significant portion of the Comptroller’s comments concerned risks to the financial system that are affirmatively caused by the government; e.g., very low interest rates and excessive regulatory costs.

SEC Commissioner Gallagher Attacks DOL’s Fiduciary Proposal

SEC Commissioner Daniel Gallagher criticized the Department of Labor’s proposed definition of “fiduciary” (the “Fiduciary Proposal”) as well as conflict of interest requirements for retirement investment advice and related proposed exemptions and amendments.

The Commissioner asserted that the Fiduciary Proposal “is grounded in the misguided notion that charging fees based on the amount of assets under management is superior in every respect and for every investor to charging commission-based fees”. He predicted that “the rule, when finalized, will harm investors and U.S. capital markets.” He also stated that the DOL “has ignored the benefits to investors of a disclosure-based approach to mitigating potential conflicts of interest” and that the DOL “substitute[d] its judgment for that of investors in deciding the type of financial professional and fee structure all investors should use when investing their retirement savings.”

Commissioner Gallagher warned that despite the industry’s “scrambling to find a workable path forward” through the SEC rulemaking under Section 913 of the Dodd-Frank Act, “those who believe that the SEC can stave off the heavy hand of DOL are chasing fool’s gold.”

Commissioner Gallagher also said that the DOL had ignored the benefits to investors of pursuing a “disclosure-based solution to the alleged excessive fee problem,” and called for the DOL to “scrap the Fiduciary Proposal and start working in a meaningful way with the Commission to address the DOL’s concerns about broker fees for retirement accounts.”

Lofchie Comment: Commissioner Gallagher emphasizes an issue that is significant to the entire debate, which is the supposed superiority of asset-based advisory fees to brokerage commissions, particularly for investors of limited means. Take the case of an investor with $50,000 in investable assets. An investment adviser charging an advisory fee of 2% a year (which is a very high rate and would be a significant spend for the client) would only receive $1,000 in income from such a client.  That $1,000 of adviser compensation must then compensate for the investment adviser’s (i) ongoing research into the client’s personal situation and (ii) actual investment advice.  In short, if the purpose of the rule is to drive small clients toward hiring investment advisers who will provide them investment advice that is both of high quality and personalized, then the question is whether the rule’s goals can be achieved as to small clients in light of the economics.

Shadow Banking / CFS Monetary Measures for June 2015

Today we release CFS monetary and financial measures for June 2015.

Market finance or “shadow banking” fell further through June, despite signs of stabilization earlier in the year.  In June, market finance in real terms was -0.9% over the month relative to a peak gain earlier in the year of +0.2% in February.

A sustained reversal of the declines would reduce financial market risks and put economic growth on a stronger footing.  Although seemingly arcane, market finance provides the fuel for corporations in the form of commercial paper and liquidity for financial markets via money market funds and repurchase agreements.

CFS Divisia M4, which is the broadest and most important measure of money, grew by 3.0% in June 2015 on a year-over-year basis versus 2.8% in May.

CFS Divisia monetary measures were developed under the direction of Professor William A. Barnett – one of the world’s leading experts on monetary and financial aggregation theory.

For the Market Finance Supplement:

For Monetary and Financial Data Release Report:

Sincerely yours,
Lawrence Goodman

Today’s WSJ: ‘Fixing the Fed’s Liquidity Mess’

Today, on the fifth anniversary of Dodd-Frank, The Wall Street Journal published a CFS op-ed titled “Fixing the Fed’s Liquidity Mess.”

CFS special counselor Stephen Dizard and I note how:

Every Treasury Secretary since the late 1930s could proclaim with confidence that the U.S. bond market is the deepest and most liquid in the world. Today’s illiquid debt markets threaten the potency of this pledge. And it puts the global economy at risk for another financial crisis.

We offer three solutions:

– Lift the federal-funds rate to neutral levels.

– Ease restrictions on market finance.

– Arrange new private-sector liquidity facilities. Severe liquidity risks will not heal themselves—and waiting for the next crisis will be too late.

View the full article.

Commissioner Aguilar Calls for Shortening the Securities Settlement Cycle in the Secondary Market

SEC Commissioner Luis A. Aguilar discussed the potential benefits of shortening the securities settlement cycle for the secondary securities market from three days to two days in a released SEC public statement.

These benefits included: (i) mitigating counterparty and other risks, (ii) lowering margin requirements for clearing agency members, (iii) reducing pro-cyclical margin and liquidity demands (especially during periods of market volatility) and (iv) bringing U.S. settlement procedures more in line with global standards.

The Commissioner noted that although such a transition would require fundamental changes across a wide number of industry practices, including those involving trade processing, asset servicing and documentation, he firmly believes a shortened market cycle “could profoundly enhance the health, robustness, and resiliency” of U.S. capital markets, particularly to deepen market liquidity.

Lofchie Comment: There appears to be broad consensus in the securities industry to make this change, subject to whether the technology is sufficient. Consideration should, however, also be given as to whether it would be necessary to continue to allow retail customers five days to make payments.

SEC Commissioner Aguilar Outlines Need to Revisit Regulatory Framework of U.S. Treasury Securities Market

In a public statement, SEC Commissioner Luis A. Aguilar discussed the report issued by the Interagency Working Group for Treasury Market Surveillance concerning the “flash crash” that occurred in the U.S. Treasury market in October 2014. Commissioner Aguilar stated that the market for U.S. Treasury securities (“Treasuries”) has undergone substantial changes in recent years, in part because of computerized trading and regulatory changes made by Dodd-Frank. In light of those changes, the Commissioner called on the SEC to lead a comprehensive review of the Treasury market.

The key proposals that Commissioner Aguilar urged regulators to consider included the following:

  • Revise Regulation ATS to make it applicable to alternative trading systems that trade U.S. Treasury securities exclusively
  • Revise Regulation Systems Compliance and Integrity to make it applicable to trading platforms that handle Treasuries
  • Develop a reporting mechanism that will give regulators the ability to monitor the Treasury market
  • Work with electronic trading platforms to develop appropriate safeguards for the Treasury cash market
  • Enhance the oversight of participants in the Treasury market
  • Enhance pre-trade price transparency in the Treasury market

According to the Commissioner, the SEC should “lead the way by reviewing its own rules and regulations with an eye toward enhancing oversight of the Treasury market.”

Lofchie Comment: The Commissioner seems to believe that the solution to any emerging market issue is yet more active regulation of the market. It is hardly obvious that that is the best approach. It seems just as likely that the market is responding rationally by pulling resources from business activities that are unprofitable because they are excessively regulated. It is difficult to see how the regulatory additions suggested by the Commissioner would address volatility in the market.

House Financial Services Committee Holds Hearing on Transparency and Accountability at the Fed

The U.S. House of Representatives’ Committee on Financial Services (“FSC”) held a hearing titled “Fed Oversight: Lack of Transparency and Accountability.” The hearing examined three aspects of the Federal Reserve from different perspectives: (i) “the lack of transparency and the opacity of internal processes at the Federal Reserve”; (ii) “[the] overreach by the Federal Reserve in expanding its authority and power beyond the authority granted to it under the Dodd-Frank Act”; and (iii) “the Federal Reserve’s refusal to comply with Congressional investigations and requests for information as well as the lack of legitimate basis for this non-compliance.”

The following witnesses testified:

  • Testimony of Mark A. Calabria, Ph.D., Director of Financial Regulation Studies, Cato Institute (written testimony)
  • Testimony of Paul H. Kupiec, Resident Scholar, American Enterprise Institute (written testimony)
  • Testimony of Alice M. Rivlin, Senior Fellow in Economic Studies, Brooking Institution (written testimony)
  • Testimony of John B. Taylor, Professor of Economics, Stanford University (written testimony)

Lofchie Comment: Two additional questions that might be usefully addressed: (i) the scope of the Federal Reserve’s expertise in securities and insurance activities over which it recently exercised substantial direct and indirect authority and (ii) the fit, or the potential lack of it, between the “banking culture” of the Federal Reserve, which tends to risk making aversion its primary objective, and the securities markets, which are meant to provide entrepreneurial capital and even accept the risk of failure.