Bank of England Governor Calls for More Authority to Regulate Derivatives, Hedge Funds and Other Non-Bank Financial Firms

Bank of England Governor and Chair of the Financial Policy Committee (“FPC”) Mark Carney called for greater regulatory authority in a letter responding to Chancellor of the Exchequer George Osborne’s points on the Committee’s primary and secondary objectives pursuant to the Bank of England Act of 1998.

Chair Carney’s recommendations were a response to Chancellor of the Exchequer George Osborne’s recent restatement of the objectives for the FPC under the Bank of England Act of 1998. Chair Carney stated that the FPC “seeks to ensure the financial system has the resilience to withstand stress while continuing to provide critical services to the real economy.” This includes “the provision of credit to business in support of productive investment” and is consistent with the FPC’s primary objective of reducing systemic risk and enhancing the resilience of the UK financial system. Although the FCP’s “view is that the core of the system is now significantly more resilient,” Chair Carney asserted that the FCP will continue to “assess the cumulative effects of reforms to make the financial system more resilient and consider whether in aggregate they have unintended undesirable effects.”

Chair Carney listed three methods that the FCP will use to maintain financial stability in line with the stated secondary objective of “boosting the UK’s productivity” and “improving competition, innovation and competitiveness in the UK financial services sector.” The three methods include: (i) taking into account the potential short-term negative effects of its actions to increase resilience; (ii) continuing to carefully design its policies in pursuit of its primary objective to contribute as far as possible to reaching the secondary objective; and (iii) assessing its work program “to consider the extent to which policies in pursuit of its primary objective can also support its secondary objective directly.”

Chair Carney stated that the FCP will “review a number of activities in the non-bank financial system over the next year, to consider potential systemic risks posed by: the investment activities of open-ended investment funds and hedge funds; securities financing transactions; the non-traditional, non-insurance and investment activities of insurance companies; and derivative transactions.”

Lofchie Comment: Query: Is the desire of banking regulators to regulate non-banks good for the global economy? To what extent are the prudential requirements that apply to banks, which can take insured deposits, relevant to private funds, that ought to be able to invest and fail?

Additional Democratic Senators Submit Letter to DOL Concerning Fiduciary Proposal

Eight Democratic members of the Senate Finance Committee submitted a letter to the DOL to “comment on the recently re-proposed [DOL] regulations defining who is a fiduciary of an employee benefit plan or individual retirement plan under ERISA.”

The Senators recommended that the DOL: (i) clarify the “best interest contract (“BIC”) exemption” by utilizing a more workable contract requirement and include listed options in the definition of assets; (ii) expand the capability of financial professionals to provide specific investment education on retirement plans; (iii) continue to encourage small businesses to sponsor their own small retirement plans; (iv) revisit the BIC exemption disclosure requirements to ensure functionality; (v) continue access to investment advice from financial advisers during rollover period; (vi) provide a level playing field for all advisers in compensation arrangements; (vii) carefully scrutinize its guidance to ensure that it does not disfavor lifetime income options over other investment options; (viii) consider further transition issues, such as the possible protection of advice provided before the applicability date and advice that was paid for before the applicability date but not provided until after the applicability date; (ix) continue coordinating with the IRS to work towards finalizing IRA guidance; and (x) ensure that the ability to make referrals to advisory programs is maintained and access to constructive online tools is not restricted.

Lofchie Comment: The Senators’ letter is a further expression of the diversity and the extensive strength of opposition to the DOL’s rule proposal.

Commissioner Aguilar Stresses Need for Clarity in SEC Orders for Enforcement Actions

In a public statement, SEC Commissioner Luis A. Aguilar called for “sufficiently detailed facts” in orders by the SEC (“Commission Orders”) to ensure that “there is no doubt as to why the Commission brought an enforcement action, why the respondent deserved to be sanctioned, and why the Commission imposed the sanctions it did.” Specifically, Commissioner Aguilar requested greater clarity concerning federal securities law violations by Chief Compliance Officers (“CCOs”) and the resulting enforcement actions. More clarity, he said, will allow the “larger CCO community” to “take notice and try to learn as much as possible about the behavior that resulted in the Commission’s enforcement action.”

Commissioner Aguilar noted that Commission Orders currently “need only include the basic facts necessary to support the charges alleged,” and that the facts behind the enforcement actions are “oftentimes negotiated” during settlement.

Commissioner Aguilar concluded by saying that “clear guidance” in Commission Orders enables the SEC to “send the right message, helps maximize the deterrent effect of enforcement actions, and, just as important, informs others as to future behavior.”

Lofchie Comment: The Commissioner makes a number of good points about the inherent tension in enforcement actions. On the one hand, actions help to guide the conduct of those who want to understand the acceptable limits of behavior; on the other, their terms are subject to negotiations that are limited to the SEC and the party who is accused of wrongdoing. In some cases, the accused party may wish to soften the effect of the statement of its wrongdoing in order to minimize reputational damage. Thus, it might be willing to bargain for a less damaging description of the facts in exchange for a settlement. That said, we also note instances in which a party may be indifferent to what is said; in which its only interest in a settlement negotiation is in reducing the amount of the direct sanctions against it. In that case, the SEC enforcement staff may have significant freedom to describe the case as it likes, which may result in the coloring of the facts by enforcement staff to justify the sanction or to change the law through its statement of the reasons for bringing the enforcement action (such enforcement actions must be approved by the SEC; they do not go through the same review process as actual rulemakings). In short, although the statement of facts in an enforcement action inherently is an uncertain guide to what actually happened, it is also a necessary (but not ideal) substitute for actual rulemaking.

While it will never be possible to make silk purses from statements of facts in enforcement actions, Commissioner Aguilar does a public service by calling attention to their significance.

Democratic Senators Highlight Costs of DOL Fiduciary Proposal

Senators Jon Tester (D-MT), Joe Donnelly (D-IN), Heidi Heitkamp (D-ND), and Angus King (D-ME) submitted a letter to the DOL to “ensure that rules related to retirement savings do not work at cross-purposes in a way that could limit investor access to education and increase costs for middle-class Americans” with respect to proposed changes to the ERISA definition of “fiduciary.” The Senators expressed their concern that “the rule in its current form could stifle access to meaningful investment advice for millions of Main Street investors.”

The Senators also recommended that the DOL: (i) maintain a neutral business model; (ii) maintain access to a variety of products in today’s marketplace; (iii) provide educational materials to help prepare individuals for retirement; (iv) prevent “significant” leakage at the point of rollover, as “evidenced by GAO’s study, ‘401(k) Plans, Policy Changes Could Reduce the Long-term Effects of Leakage on Workers’ Retirements Savings’“; (v) allow financial professionals to engage small business without triggering fiduciary duties; (vi) permit current investors to forgo the proposed process if they so choose; (vii) solicit meaningful input from the SEC and FINRA; and (viii) engage relevant stakeholders, including the Senators’ offices, as the rulemaking process continues.

Lofchie Comment: The DOL’s rule proposal with respect to fiduciaries has attracted a fairly remarkable range of opposition from: both buy-side and sell-side market participants, both Democratic and Republican elected officials, and other regulators. In ordinary times, it would seem odd for a regulator to proceed with pushing forward a rule that has attracted criticism from so many divergent sources.

In any case, the opposition to the rule makes a common point: burdens and limitations put on the financial industry are also burdens and limitations put on those served by the financial industry. Expenses imposed on the financial industry must be passed through to customers. Prohibitions put on the financial industry are prohibitions that are also passed through to customers. None of this is to resist the notion that it is proper to impose burdens, limits, and prohibitions on the financial industry. But those who do must be willing to justify the indirect negative effects of their regulations, and not to pretend that their effects are not felt by customers. When regulators are willing to have an open discussion of the full costs, as well as the benefits of regulation, then society can have a real conversation as to what rules truly make sense.

Shadow Casting

We are delighted that Center for Financial Stability (CFS) metrics are providing a standard to measure “shadow banking” or more aptly “market finance.”

Our analytics were featured in The “CFA Institute Magazine” July/August cover story, “Shadow Casting” by Maha Khan Phillips.

In the article, Ms. Khan Phillips questions if the financial industry should be worried about the potential growth in shadow banking.  She also investigates if regulators are being overzealous, or not zealous enough.

At CFS, we know market finance is undoubtedly compromising liquidity in international financial markets. According to CFS data, shadow banking is down a stunning 46% in real terms since it’s peak in 2008.

CFS believes that regulation has gone too far. There are very significant liquidity concerns in the market and regulation will make it worse.

To view the full article:

Financial Stability Board to Go Slow on Risk Analysis of Investment Funds

The Financial Stability Board (FSB) announced that it had decided to wait to finalise the assessment methodologies for non-bank non-insurer global systemically important financial institutions (NBNI G-SIFIs) until the current FSB work on financial stability risks from asset management activities is completed.  SIFMA Asset Management Group (“SIFMA AMG”) applauded FSB’s decision.  SIFMA AMG also stressed the need for transparency in FSB proceedings and noted that industry engagement and consulting should precede any activity-based policy recommendations. SIFMA AMG recommended that the FSB conclude its asset management entity assessment workstream and allow specialized individual regulators to review the activities of asset managers and their respective funds.

Lofchie Comment: FSB’s decision is consistent with prior SIFMA AMG recommentations.