CFTC Commissioner Bowen Urges International Regulators to Adopt Similar Rules

CFTC Commissioner Sharon Y. Bowen argued that “regulations and international financial standards need to be broadly aligned, but also be strong enough to ward off undue systemic risk and flexible enough to allow for growth.” In an address before the CFTC Annual Symposium for International Market Authorities, Commissioner Bowen set forth her perspective on the remaining CFTC rulemakings concerning position limits, capital requirements for swap dealers, corporate governance, Regulation AT and cybersecurity. She also weighed in on international developments affecting U.S. markets that “underscore the need for cooperation.”

  • Position Limits: Commissioner Bowen asserted that “a strong position limits rule would not only work to reduce excessive speculation, which can be a major source of systematic risk, but would also make it more difficult for certain market participants to engage in market manipulation successfully.” She noted that CFTC staff has “included within the proposed rule various enumerated hedge exceptions, as well as a process and standard for exchanges to provide market participants the ability to hedge in certain situations.” She hoped that the rule would be finalized within the next few months.
  • Capital Requirements: Commissioner Bowen anticipates that the CFTC will propose capital requirements for swap dealers and major swap participants before the end of the year. While she acknowledged that imposing onerous capital requirements, “such as 35% or even 50% of a portfolio, would inhibit trading and could slow economic growth,” she noted that “[r]equiring a firm to hold a few million dollars in capital against a multi-billion dollar trading book isn’t a regulation that will actually reduce systemic risk and protect firms from imploding. Instead, that kind of de minimis requirement is just a fig leaf.”
  • Corporate Governance: Commissioner Bowen argued for a robust corporate governance rule, including fitness standards that require board directors to have a base understanding for matters under their review, limiting the tenure of independent members of audit and compensation committees, and requiring firms to disclose the level of diversity on their boards.
  • Regulation AT: Commissioner Bowen said that she was “particularly proud of how [proposed Reg. AT] addresses the massive dangers posed by faulty code within algorithmic trading systems.” She noted that the proposed Regulation AT would impose stringent testing requirements on algorithmic trading systems, including testing of new codes prior to use, and regular backtesting using historical data.
  • Cybersecurity: Commissioner Bowen stated that the proposed cybersecurity rule would impose specified testing requirements on DCOs, DCMs, SEFs and SDRs to address the threat of cyber breaches.
  • International Cooperation: Commissioner Bowen cautioned against regulators “drop[ping] to the lowest common denominator when it comes to regulation” and urged global regulators to “fight to craft regulations and international standards that are workable, but provide robust protections to the financial system and to investors.” She encouraged global regulators to consider adopting similar rules as those of the CFTC, emphasizing that: “[u]ltimately, we’re all in this together, and I’d rather have an excellent regulation that is widely adopted across the globe to a perfect regulation that is only adopted here in America.” Commissioner Bowen commended global regulatory cooperation during “Brexit” and opined that the incident demonstrates the importance of strong international cooperation.

Lofchie Comment: Commissioner Bowen’s warning that a single country’s regulators should not go it alone is true. The comment might best be directed at her own agency, the CFTC. There is no other regulator whose conduct has made it such an obvious target of her warning.

Treasury Secretary Lew Defends FSOC Before House Financial Services Committee

In testimony before the House Financial Services Committee on the Financial Stability Oversight Council (“FSOC”) 2016 Annual Report, Treasury Secretary Jacob Lew stated that “reforms adopted in the Dodd-Frank Act, including the creation of the Council, have made the financial system safer, more resilient, and supportive of long-term economic growth.”

Secretary Lew stated that the Annual Report is “a key mechanism for public accountability and transparency regarding the Council’s work.” He identified twelve themes in the Report: (i) cybersecurity, (ii) risks associated with asset management products and activities, (iii) capital, liquidity and resolution, (iv) central counterparties, (v) reforms of wholesale funding markets, (vi) reforms relating to reference rates, (vii) data quality, collection and sharing, (viii) house finance reform, (ix) risk management in an environment of low interest rates and rising asset price volatility, (x) changes in financial market structure and implications for financial stability, (xi) financial innovation and migration of activities, and (xii) global economic and financial developments.

As to the overall impact of the FSOC since inception, he argued:

As the forum designed to bring the financial regulatory community together to collaboratively identify and respond to potential threats to financial stability, the [Financial Stability Oversight] Council has done what Congress established it to do, including asking the tough questions that help us make our financial system safer.

Secretary Lew stated that the FSOC:

  • published “a number of findings regarding potential liquidity and redemption and leverage risks, based on careful analysis that included engagement with key stakeholders”;
  • plans to provide timely public updates as analysis continues;
  • will monitor market responses to the implementation of SEC money market mutual fund reforms that go into effect next month; and
  • will continue to monitor for potential threats posed by nonbank financial companies.

Lofchie Comment: The FSOC is a largely partisan organization. It is comprised of members of a single political party, and is made up of regulators assessing the impact of their own regulation. This results in the FSOC’s work product appearing to be more politically motivated than policy-minded, and more self-aggrandizing than self-critical.

The FSOC was intended to bring together perspectives from different regulators; however, it is clearly dominated by the banking regulators and, therefore, the work product very clearly imposes that perspective on the world (which is quite different from the perspective of participants in the capital markets). This perspective, or bias, is most evident by the FSOC’s focus on funds or, as the FSOC calls them, “shadow banks.”

Finally, the FSOC seems oddly focused on securities lending and other securities financing transactions, and inappropriately indifferent to big picture concerns that seem much more likely to create systemic risk, such as the potential for failures by municipal entities or the underfunding of pension plans.

SEC Accountant Addresses Recent Developments in Financial Reporting

SEC Interim Chief Accountant Wesley R. Bricker outlined ways in which auditors, and others responsible for financial reporting, can “reinforce the reliability and credibility of financial reporting for investors” under the new FASB credit loss standard. In remarks before the AICPA National Conference on Banks & Savings Institutions, Mr. Bricker addressed:

  • the FASB’s recent completion of its multi-year standard setting process for credit losses, which requires earlier recognition of credit losses on many loans, securities and other financial assets;
  • existing SEC rule staff guidance for maintaining books and records for credit losses under current Generally Accepted Accounting Principle requirements, including continued focus on internal control over financial reporting; and
  • the importance of coordination among all stakeholders in the transition and implementation activities relating to the new credit loss standard.

Mr. Bricker emphasized that “the issuance of the new credit loss standard represents a significant enhancement in the quality of financial reporting by providing financial statement users with more decision-useful information about the expected credit losses related to many financial assets.” He highlighted that:

[C]ompanies will be required to immediately recognize expected losses instead of deferring losses until incurred, which should result in more timely reporting of losses to investors. . . .

Mr. Bricker is part of the SEC Office of the Chief Accountant which maintains oversight over the Financial Accounting Standards Board and the Public Company Accounting Oversight Board.

Lofchie Comment: Mr. Bricker’s observations raise a question as to whether “earlier recognition” of losses may bring the SEC into conflict with the banking regulators, who may have their own views as to when a loss should be recognized.


SEC Chair White Describes Challenges to Global Securities Regulation

In remarks before the Legal Practice Division at the International Bar Association Annual Conference, SEC Chair Mary Jo White discussed the SEC’s “robust and wide-ranging work” to regulate the global securities marketplace.

Chair White emphasized:

  • current work by the SEC to modernize regulation of the asset management industry, “which is of particular interest to other domestic and international authorities assessing potential systemic risks to financial stability.” In this regard, Ms. White noted the SEC’s imposition of “new required reporting about separately managed accounts and their use of derivatives and borrowing”;
  • the “significant supervisory challenge” of being able to examine non-U.S. based registrants for compliance with SEC laws and regulations; and
  • the SEC Foreign Corrupt Practices Act enforcement program, “which is so dependent on international cooperation for its success.”

Lofchie Comment: It is noteworthy that SEC Chair White links the SEC’s “modernization” of the regulation of the asset management industry to systemic risk. The idea that the SEC should regulate the asset management industry to protect clients is obvious; likewise, that the SEC should regulate the industry to prevent any trading or investment misconduct of advisers from injuring third party market participants is obvious. That the SEC should be regulating investment advisers so as to limit systemic risk is far less obvious and, in fact, questionable. It is not merely that the SEC would not seem to have the expertise, resources or focus to take on this task in light of its other obligations; it goes beyond that. By what authority should the SEC be imposing limits on what investment managers, particularly managers of private funds, buy and sell? Could the SEC tell fund managers that they are too concentrated in oil and that they must diversify into solar, or into healthcare? This seems to be a function that the government should take not take on.

Regarding the SEC’s efforts to collect information regarding the use by advisers of leverage and derivatives, we have commented numerous times that the SEC’s Form PF (designed in connection with the Financial Stability Oversight Commission) is – to anyone who understands how leverage, derivatives, and bankruptcy work – a massive collection of data that is almost completely useless.

Comptroller Curry Asserts That Post-Crisis Financial System Is Stronger

Comptroller of the Currency Thomas J. Curry asserted that regulatory reforms since 2008 have improved capital, limited leverage, enhanced liquidity and improved supervision. In remarks at the 2016 Annual Robert Glauber Lecture at the Harvard Kennedy School, he stated that the U.S. “banking system is now as well capitalized as any in the world.”

Mr. Curry emphasized that:

  • Improving Capital. “The benefits of a strong banking system built on a strong capital base should not be forgotten in debates about striking the right balance in capital standards.”
  • Limiting Leverage. Leverage ratios should “serve as an additional line of defense, or backstop, to the risk-based capital measures.”
  • Enhancing Liquidity. Implementing the Liquidity Coverage Ratio and the proposed Net Stable Funding Ratio are “steps in the right direction.”
  • The importance of effective supervision is perhaps the crisis’ greatest lesson” – supervision is “the regulators’ primary means of affecting behavior and promoting a healthy risk culture.”

He asserted:

In the end, the measure of this work is whether the financial system is now stronger, more resilient, and more capable of satisfying the financial needs of the United States, and can adapt to changing consumer demands, market opportunities, and new technology. I think that answer is “yes.”

Mr. Curry cautioned regulators that “now is not the time to let our guard down” and observed that “[t]hose who have been in this business for more than one cycle know a downturn will come,” he concluded that “lessons from 2008 were not really new lessons,” after all, but reminders of basic principles.

Lofchie Comment: Regulators may want to consider tempering these kinds of victory speeches with a little less self-congratulation and a little more reflection. Just by the law of averages, not every rule works or is worthwhile. Regulators may want to allow for the possibility that the massive regulatory burdens that have been imposed since the financial crisis may require some reconsideration.

Regulators might ask, for example, why so many community banks are shutting down at such a rapid rate. Or they might consider whether the combination of: (i) expensive new regulatory burdens, (ii) diminution of powers to engage in previously profitable activities, (iii) the effect of abnormally low interest rates and interest rate spreads, and (iv) competition from new fintech firms that create significant new issues for banks of all sizes could negatively affect a bank’s ability to cover its costs and what that might mean to the economy.

CFS Monetary Measures for August 2016

Today we release CFS monetary and financial measures for August 2016. CFS Divisia M4, which is the broadest and most important measure of money, grew by 4.9% in August 2016 on a year-over-year basis, maintaining the same growth rate as in July.

CFS Divisia indices can be found on our website at Broad aggregates are available in spreadsheet, tabular and chart form. Narrow aggregates can be found in spreadsheet form.

For Monetary and Financial Data Release Report:

Bloomberg terminal users can access our monetary and financial statistics by any of the four options:

3) {ECST} –> ‘Monetary Sector’ –> ‘Money Supply’ –> Change Source in top right to ‘Center for Financial Stability’
4) {ECST S US MONEY SUPPLY} –> From source list on left, select ‘Center for Financial Stability’

A Questionable Delegation of Authority: Did the SEC Go Too Far When It Delegated Authority to the Division of Enforcement to Initiate an Investigation?

A seemingly innocuous decision by the Commission may have had a tremendous impact on the SEC’s Enforcement Program.  In 2009, under Chairman Mary Shapiro, the Commissioners of the Securities and Exchange Commission delegated authority to the Director of Enforcement to open formal orders of investigation of persons and entities.  The Director then sub-delegated authority to Regional Directors, Associate Directors, and Specialized Unit Chiefs.  A formal order of investigation is the precursor to the SEC Staff issuing subpoenas for documents and testimony.  Prior to the delegation of authority, the Division of Enforcement was required to present reasons to the Commission for the request for a formal order, and the Commission would vote, often in a summary fashion, to grant or deny the formal order.  The rationale for delegating formal order authority was that the Commission rarely declined to issue the formal order.  In fact, some statistics suggested that the Commission approved almost 99% of the requests by the Staff to issue a formal order of investigation.  Of course, whatever the approval rate, the fact that the Commission needed to approve a formal order provided an important internal check to prevent abuse.  In other words, the very fact that approval was required may have prevented the Staff from pursuing questionable investigations.

The delegation of formal authority has raised three concerns.

First, the fact that formal orders (and thus subpoenas) can be obtained now with relative ease – an SEC Enforcement Staff lawyer simply can request a formal order from his or her ultimate supervisor – has resulted in the Staff resorting to subpoenas earlier in the enforcement investigative process.  Under the prior system, the Enforcement Staff often would call the entity under investigation and engage in informal detective work prior to resorting to a request from the Commission for a formal order.  That informal detective work benefited the Staff by allowing the Staff to forgo a more elaborate investigation when the initial, informal steps gave assurances there was no wrongdoing.  Companies benefited by avoiding the costly production of thousands or millions of documents in response to an SEC subpoena by instead engaging in an initial conversation and voluntary production of key documents to demonstrate there was no violation.  Now, under delegated authority, the Staff does not need to exercise those informal investigative steps, resorting instead to the resource intensive subpoena for documents that often consumes Enforcement Staff resources for several months and, in some instances, unnecessarily.

The second concern with delegated authority is that it eliminated a process whereby the Commission can be involved in enforcement cases at the early stages.  Without the authority to issue formal orders, the Commission now rarely is briefed on any particular enforcement action until the late stages when the Staff seeks to bring charges.  The Commission does not have the visibility to provide guidance to the Enforcement Staff prior to the case unfolding.  The Staff is free to pursue any investigation no matter how resource-intensive to the SEC or costly to an individual or entity, without Commissioners even being aware.   Moreover, under the prior system, the Commissioners would know precisely the suspicions that prompted the initial formal order and could measure those suspicions against the final enforcement recommendation, which might differ substantially.  In order words, the Commissioners might find it informative whether a multi-year investigation into the initial issues yielded no enforcement action on those concerns but instead resulted in an enforcement action concerning entirely different issues.

The third concern with delegated authority is the balkanization of investigative authority.  Under the prior system, the fact of an investigation would be raised to the highest levels of the Commission – to both the Director and the Commission – and would be known to anyone in the Division of Enforcement who wished to attend the closed Commission meeting where the matter was discussed.  This centralization enabled a Staff member in a regional office to see areas that were being investigated by a different regional office.  Moreover, senior officers in the Division of Enforcement could offer assistance to others in the Division upon hearing about a new investigation.   The system enabled greater flow of communication and cooperation.  Under the new delegated authority, a formal order of investigation could be opened by one regional office without others in the Division even knowing at the time.

The Commission should re-evaluate whether it should continue with its delegation of authority to initiate formal investigations.  The authority to initiate an investigation is a power that might best reside with the five Commissioners.

______________________________________________________________________The Center for Financial Stability (CFS) is a private, nonprofit institution focusing on global finance and markets. Its research is nonpartisan. This publication reflects the judgments and recommendations of the author(s). They do not necessarily represent the views of Members of the Advisory Board or Trustees, whose involvement in no way should be interpreted as an endorsement of the report by either themselves or the organizations with which they are affiliated.

CFTC Chair Massad Will Recommend RTO-ISO Exemption from Private Right of Action under the CEA

CFTC Chair Timothy G. Massad notified legislators that he will recommend that the CFTC exempt regional grid operators – Regional Transmission Orders (“RTOs”) and Independent System Operators (“ISOs”) – from all private rights of action under CEA Section 22.

In a letter responding to concerns of certain legislators, Chair Massad acknowledged concerns raised about private actions that “could create costs within markets in ways that regulators do not anticipate.” He noted that “several state consumer advocate offices charged with protecting consumers submitted comments asserting that private rights of action could inadvertently introduce regulatory uncertainty and increase costs for consumers.”

Chair Massad stated:

While private rights of action will remain critical overall in our markets, I am persuaded that, in this instance, their preservation could result in greater costs and uncertainties without necessarily enhancing supervision of markets or consumer protection.

Chair Massad urged the CFTC to “continue to retain the authority to pursue fraud and manipulation” within RTO-ISO markets. Additionally, he emphasized that the “CFTC’s Whistleblower Program also is available to those aggrieved, providing another path for redress.”

Lofchie Comment: Chair Massad’s decision marks a positive step toward recognizing the benefits of limiting CFTC jurisdiction and deferring to the concerns of other regulatory agencies. More steps should be considered. For example, the CFTC should restore the exemption afforded previously to SEC-registered investment companies from being regulated doubly as commodity pools. Such double regulation is unnecessary, imposes needless costs on retail investors in mutual funds that are also regulated as commodity pools, and wastes the CFTC’s internal resources as well.

GDP-Linked Bonds

A recent paper, “Making a reality of GDP-linked sovereign bonds,” contends that this is an opportune time to consider how to establish a broad market for such bonds. The paper, by staff of the Bank of England with contributions from the Banco Central de la República Argentina and the Bank of Canada, proposes four next steps: (1) build on existing work on a draft term sheet; (2) develop guidelines for when GDP-linked bonds are most beneficial to a sovereign issuer outside of a restructuring; (3) assemble principles for using GDP-linked debt in debt restructurings; and (4) improve understanding about pricing of GDP-linked bonds.

(Thanks to David Beers of the Bank of England for notification about the paper. I  express no personal position on the subject here.)

International Money: Interview with Professor Richard N. Cooper

Professor Richard N. Cooper – advisor to many U.S. Presidents on international monetary affairs – was recently interviewed by the Center for Financial Stability on his decades of experience at the center of international monetary policy.

Highlights include:

  • Evolution of the international monetary system,
  • Insights into Nixon Shock (cessation of the gold standard),
  • System of floating exchange rates,
  • Recent revelations regarding the 1944 Bretton Woods Conference,
  • China and measures to move forward,
  • Proposals for the future.

We thank Kurt Schuler and Robert Yee for such a wonderfully insightful exchange and Richard Cooper – Maurits C. Boas Professor of International Economics at Harvard and formerly Under-Secretary of State for Economic Affairs, and Chairman of the Federal Reserve Bank of Boston.

To view the full interview: