IOSCO Examines Corporate Governance Regulation

The Corporate Governance Task Force (“CGTF”) of the IOSCO Growth and Emerging Markets (“GEM”) Committee issued a final report in which it analyzed the following “key topics” of corporate governance: (i) board composition, (ii) remuneration and incentive structures, and (iii) risk management and internal controls. The CGTF based its conclusions on a survey of GEM Committee members, and of relevant institutions and market entities in over 30 jurisdictions.

In the report, the CGTF emphasized that “[c]orporate governance is a work in progress,” and stated that its recommendations are intended “to help regulators consider possible ways for improvements in their corporate governance regulatory frameworks” (emphasis in original). The CGTF also stressed the importance of the role of the regulator in incorporating jurisdictional best practices into larger regulatory frameworks:

Capital markets regulators should take a relevant role in ensuring the regulatory frameworks consider the best governance practices within their jurisdictions. Accordingly, their views should be an increasingly important reference on the subject in global debates.

Additionally, the CGTF recommended that regulators:

  • require companies to indicate as concisely as possible the “main risks resulting from the risk identification methodology adopted by the company[ies],” and to describe how those risks “affect the business”;
  • emphasize social and cyber risks, and sustainability, proportionately when regulating risk reporting and management;
  • encourage companies to adopt integrated reporting by interacting with their stakeholders, as well as through other means;
  • encourage periodic self-assessment reports by companies’ boards that address the “efficiency and appropriateness of companies’ systems and controls, including identified deficiencies and the appropriate corrective action to be taken”;
  • compare analyses of internal controls and systems reported by external auditors with companies’ descriptions and their boards’ self-assessment reports;
  • encourage companies to establish specialized subcommittees in order to support board performance; and
  • “consider market conditions and characteristics, segments and scale of companies, so that they do not impose excessive or unnecessary regulatory costs” in mandating specialized risk committee requirements.

Lofchie Comment: One of the more interesting parts of the CGTF’s report is the discussion of “diversity” in corporate boards of directors, since regulators from different countries expressed contrasting views on the meaning and significance of diversity, and the degree to which it should be treated as a governmental goal.

SEC Launches Tick Size Pilot Program

The SEC notified investors that a Tick Size Pilot Program went into effect on October 3, 2016. The program effectively widened the minimum quoting and trading increment (i.e., “tick size”) for certain small capitalization stocks. According to the SEC, the Tick Size Pilot Program is intended to study the effect of tick size on the liquidity and trading of small capitalization stocks.

The pilot program includes the stocks of companies with (i) $3 billion or less in market capitalization, (ii) an average daily trading volume of one million shares or less, and (iii) a volume-weighted average price of at least $2.00 for every trading day. The pilot program involves a control group of approximately 1,400 securities and three test groups with 400 securities in each, all of which were selected by a stratified sampling:

  • pilot securities in the control group are quoted at the current tick size increment of $0.01 per share and trade at the currently permitted increments;
  • pilot securities in the first test group are quoted in $0.05 minimum increments but continue to trade at any price increment that currently is permitted;
  • pilot securities in the second test group are quoted in $0.05 minimum increments and trade at $0.05 minimum increments, subject to a midpoint exception, a retail investor exception, and a negotiated trade exception; and
  • pilot securities in the third test group are subject to the same terms as the second test group and also are subject to the “trade-at” requirement to prevent price matching by a person who is not displaying orders at the price of a trading center’s best “protected” bid or offer, unless an enumerated exception applies.

The SEC reminded investors that the Tick Size Pilot Program, which commenced on October 3, 2016, will run for a two-year period.

Lofchie Comment: On the one hand, it is good that the SEC is conducting experiments to determine how the market system functions and whether liquidity for small issuers can be improved. On the other, it is unclear why SEC is focusing on this particular experiment. This kind of program seems unlikely to produce meaningful results. Even if the results should prove meaningful, more useful experiments could have been conducted. For some reason, this broad tick test caught Congress members’ fancy (in the JOBS Act) when they ought to have focused their attention on compelling the SEC to request public comment on which tests to try before pursuing a given course.

SEC Adopts Enhanced Regulatory Framework for Securities Clearing Agencies

The SEC voted to adopt final rules to require securities clearing agencies that are deemed systemically important or that are involved in complex transactions (“covered clearing agencies”) to “establish, implement, maintain, and enforce policies and procedures reasonably designed to address all major aspects of [their] operations, including [their] governance, risk management (including financial, business, and operational risks), access requirements, and settlement and depository systems.” In addition, the SEC voted to propose the application of these enhanced standards to all SEC-registered central counterparties.

The adopted rules apply to SEC-registered securities clearing agencies that have been designated as systemically important by the Financial Stability Oversight Council (“FSOC”). The rules require a covered clearing agency to have policies and procedures that, among other things:

  • establish the qualifications of members of boards of directors and the senior management of covered clearing agencies, specify clear and direct lines of responsibility, and consider the interests of relevant stakeholders in covered clearing agencies;
  • address recovery and wind-down planning;
  • address daily stress testing, monthly reviews and annual validation of credit risk models;
  • set and enforce appropriately conservative haircuts and concentration limits, and subject them to review annually at the very least;
  • mark positions to market, collect margin at least daily, and conduct daily backtesting and monthly sensitivity analyses, and perform model validation at least annually;
  • address holding “qualifying liquid resources” that are sufficient to withstand the default of the participant family that would generate the largest aggregate payment obligation in extreme but plausible market conditions;
  • test the sufficiency of their liquidity providers;
  • provide for holding liquid net assets funded by equity equal to at least six months of current operating expenses in order to allow covered clearing agencies to continue operations during a recovery or wind-down; and
  • maintain a viable plan, which must be approved by boards of directors and updated at least annually, for raising additional equity should that of covered clearing agencies fall close to or below the required amount.

In his statement at the open meeting, SEC Commissioner Michael S. Piwowar emphasized that he voted for the final rule and proposal, but expressed his misgivings:

I support today’s adopting and proposing releases as the best approach we currently have at setting heightened standards for the clearing agencies we regulate. However, this entire effort has the eerie feeling of re-arranging deck chairs on the Titanic. I hope that history will prove me wrong, but I fear that the Dodd-Frank Act has created too many icebergs for our financial system to safely navigate.

SEC Commissioner Kara M. Stein expressed reservations about the laxity of the final rules, which she said only “marginally decrease the risk posed by systemically important clearing agencies.”

Comments on the final rules must be submitted within 60 days after their publication in the Federal Register. If adopted, the final rules also will become effective 60 days after their publication in the Federal Register. Covered clearing agencies will be required to comply with the final rules no later than 120 days after the effective date.

Lofchie Comment: In statements that might have sounded familiar to Goldilocks, the three SEC commissioners voiced three different views on the final rules: Commissioner Stein said that they do too little, but are better than nothing, Commissioner Piwowar complained that they comprise a part of an ill-conceived scheme of regulation that exacerbates the problem of too-big-to-fail, while Chair Mary Jo White declared that the rules are just right.

Coats on “What is wrong with our monetary policy?”

Former Chief of the SDR Division at the IMF Warren Coats unpacks a statement by Senator Jeff Merkley that

“The Fed should be using its economic expertise to highlight the long-term devastating impacts of failing to provide the opportunity for the skills needed for the economy of the future.” [1]

Warren’s paper examines monetary management in the United States – since the Nixon shock of closing the gold window and launching wage and price controls – to research the statement above. He finds:

  • No tradeoff exists between employment and inflation in the long run.
  • Radical innovations in New Zealand sparked rules that ultimately fell short of expectations.
  • NGDP targeting ignores the benefits of stable money.
  • The return to a hard anchor for monetary policy – such as the SDR – is attractive.

Although CFS is not promoting the idea of a newfound use for the SDR, monetary policy is in need of a rethink. Warren’s ideas are thoughtful and informative.

To view the full paper:

As always, CFS welcomes opinion.

[1] Ylan Q. Mui, The Washington Post Aug. 27, 2016