Federal Register: CFTC Proposes to Simplify Exemptive Process for Foreign Clearing Organizations

The CFTC proposed amendments to codify policies and procedures for a non-U.S. clearing organization to obtain an exemption from registration as a derivatives clearing organization (“DCO”). The amendments were published in the Federal Register. Comments must be received on or before October 12, 2018.

As previously covered, the proposal would amend CFTC Parts 39 and 140, which address procedures for registration as a DCO. The proposal would (i) establish a new rule, CFTC Rule 39.6, that would create a regulatory framework for exempting non-U.S. clearing organizations from DCO registration with the CFTC, (ii) mandate clearing organizations to “observe the principles for financial market infrastructures in all material respects and be in good regulatory standing in its home country” under proposed regulation 39.6(a)(1)(ii), and (iii) obligate that a memorandum of understanding satisfactory to the CFTC be in effect between the agency and the clearing organization’s home country regulator.

International Regulatory Groups Analyze “Interconnectedness” between CCPs and Clearing Members

In a new report on interconnectedness and systemic risk, IOSCO, the Financial Stability Board, the Committee on Payments and Market Infrastructures and the Basel Committee on Banking Supervision (collectively, “international standard-setting bodies”) mapped the network of relationships between central counterparties and their clearing members. This report is the second issued by the international standard-setting bodies on central clearing interdependencies. (The first is available here.)

The regulators found, among other things:

  • “prefunded financial resources are concentrated at a small number of CCPs” (e.g., the two largest cross-border central counterparties (“CCPs”) account for roughly 40% of total prefunded financial resources);
  • CCP exposure is concentrated, with the 11 largest clearing members connected to 16-25 CCPs;
  • the network of relationships between CCPs and other financial institutions is characterized “by a core of highly connected CCPs and entities and a periphery of less highly connected CCPs and entities”;
  • only a small number of entities control the provision of each of the critical services required by CCPs; and
  • clearing members and their affiliates are also providers of critical services required by CCPs, such as being custodians or liquidity providers, so that if a significant clearing member were to default, it is very possible that the same entity could also be a vital service provider to the CCP.

The regulators cautioned that they did not assess potential “feedback mechanisms” that could amplify any initial stress. Further, they noted, the study was not intended to address the risk of central clearing, but rather to evaluate levels of interconnectedness. The regulators noted that central clearing is “intended to reduce the risk of contagion in financial markets, but it does not eliminate it”.

Lofchie Comment: Has mandated central clearing exacerbated interconnected risk and too big to fail? If so, would further mandates make it worse? Are the results of mandated central clearing playing out the way in which the regulators expected, particularly in terms of the very great concentration of risk in a very small number of firms and the very small number of firms able to provide broad access to CCPs?

FinCEN Director Examines Virtual Currency Regulatory Obligations

Financial Crimes Enforcement Network (“FinCEN”) Director Kenneth A. Blanco outlined agency efforts to protect financial institutions from fraud relating to new uses of financial technology, and described “how FinCEN is approaching virtual currency.”

Mr. Blanco emphasized FinCEN’s jurisdiction over virtual currency stating: “individuals and entities engaged in the business of accepting and transmitting physical currency or convertible virtual currency from one person to another or to another location are money transmitters subject to the AML/CFT requirements of the BSA and its implementing regulations.”

In remarks delivered at the 2018 Chicago-Kent Block Tech Conference, Mr. Blanco argued that innovation in financial services is a double-edged sword: it provides customers with greater access to various services but it can create opportunities for criminals. Mr. Blanco declared that FinCEN is focused on (i) expanding its understanding in the rapidly developing technological landscape, (ii) identifying risks, (iii) closing gaps and (iv) fostering smart innovation. FinCEN is also working to establish information-sharing programs such as FinCEN Exchange, related cyber defense programs and increased suspicious activity reports (“SARs”) to help the financial services sector protect itself from threats.

Mr. Blanco recounted FinCEN’s efforts as to virtual currency and initial coin offerings, including a listing of each of the major FinCEN administrative rulings as to the treatment of such products. In particular, Mr. Blanco stated that FinCEN expects businesses involved in initial coin offerings to meet all of their obligations in regard to anti-money laundering (“AML”) and combating the financing of terrorism. Mr. Blanco noted that financial institutions have been more active in the past couple of years as demonstrated by the increase in filings of virtual currency SARs.

Lofchie Comment: Not that one more cautionary warning was needed, but here is another cautionary warning that all firms involved with virtual currency or initial coin offerings must be extremely diligent in their procedures as improper activities may result in violations of not only securities and commodities laws, but also in those regarding money laundering.

Attorneys General Urge SEC to Strengthen Proposed Regulation Best Interest

A coalition of 17 Attorneys General (“AGs”) urged the SEC to bolster the requirements set out in proposed Regulation Best Interest (the “Proposed Rule”).

In a comment letter to the SEC, the AGs criticized the Proposed Rule, asserting that it (i) sets out a weak “best interest” standard that falls short of a uniform fiduciary standard and fails to require broker-dealers to act as fiduciaries for their clients; (ii) fails to sufficiently resolve broker-dealer conflicts of interest by turning a blind eye to harmful practices and erroneously relying on the “good faith of broker-dealers to fashion effective policies”; (iii) relies too heavily on disclosures, which alone are not effectual in protecting investors; and (iv) is fraught with ambiguities, leaving key terms undefined and causing confusion for regulators and investors.

The AGs recommended the following:

  • the Proposed Rule should be altered to impose a uniform fiduciary standard on broker-dealers and investment advisers;
  • the SEC should enhance certain disclosure requirements;
  • protections against conflicts of interest should be adopted; and
  • the SEC should ensure that all key terms and provisions are clearly defined.

Lofchie Comment: It is a safe bet that any time a regulatory advocate describes its recommendations as being “common sense,” they are not. According to the state attorneys general, imposing additional burdens on broker-dealers can be done “without compromising investor access to financial professionals, the availability of diverse financial products, or choice in fee arrangements.” That seems a remarkable conclusion: how can it possibly be that one can impose material additional requirements as to the provision of a service, and yet there is no effect on the availability or cost of that service? If it is so obvious that this can be accomplished as to securities transactions, then surely the NYC subway service can be similarly enhanced without any increase in cost or other ill effect.

There are certainly arguments that can be made in favor of Regulation Best Interest. A reasonable starting point should be to ask whether the regulation is worth the increased costs and the diminished availability of certain services. This requires advocates of the proposed regulation to be at least willing to concede the existence of trade-offs, and (even better) to attempt to quantify them to the extent possible. If there are no trade-offs, and if everything is free, a subway train should have already arrived at the station.

International Regulators Launch “Global Financial Innovation Network”

Several international regulatory agencies collaborated in the creation of the “Global Financial Innovation Network” (“GFIN”). The new network will focus on regulatory issues related to emerging technologies. There are 11 regulatory agencies in the new network including the Consumer Financial Protection Bureau and the UK’s Financial Conduct Authority.

In a draft consultation document, the agencies explained three major functions of the initiative: (i) information- and knowledge-sharing among regulators, (ii) collaboration in exploring major policy questions and (iii) “cross-border trials” instituted to aid companies as they deal with multi-jurisdictional regulatory challenges. The network is intended to serve as a resource for FinTech companies navigating the complicated web of international regulation. The regulators anticipate that GFIN will increase the speed at which innovative products are able to reach international markets. They also argue that the GFIN will promote transparency and investor protection.

The GFIN proposed the following as its organizational mission statement:

“The GFIN is a collaborative policy and knowledge-sharing initiative aimed at advancing areas including financial integrity, consumer wellbeing and protection, financial inclusion, competition and financial stability through innovation in financial services, by sharing experiences, working jointly on emerging policy issues and facilitating responsible cross-border experimentation of new ideas.”

The GFIN is requesting feedback on its proposed objectives, functions and structure. Comments must be submitted by October 14, 2018.

President Trump Imposes Sanctions against Iran

The Trump administration issued a new Executive Order (the “New Iran E.O.”) imposing certain U.S. sanctions against Iran, effective August 7, 2018.

Consistent with President Trump’s May 8 announcement ending U.S. participation in the Joint Comprehensive Plan of Action (Iran nuclear deal), the New Iran E.O. restores sanctions related to, among other things: (i) the Iranian government’s purchase or acquisition of U.S. dollars; (ii) Iran’s trade in gold and precious metals; (iii) the sale, supply or transfer to or from Iran of graphite, raw or semi-finished metals, and software for integrating industrial processes; (iv) significant transactions related to Iran’s national currency, the rial, and the maintenance of significant funds or accounts outside the territory of Iran denominated in the Iranian rial; (v) the purchase, subscription to, or facilitation of the issuance of Iranian sovereign debt; and (vi) Iran’s automotive sector.

In addition, certain wind-down authorizations expired at 11:59 p.m., EDT, on August 6, 2018, namely, those related to (i) the importation into the United States of Iranian-origin carpets and foodstuffs; (ii) activities related to the export or reexport to Iran of commercial passenger aircraft and related parts and services; and (iii) activities undertaken pursuant to General License I that relating to contingent contracts for activities related to passenger aircraft-related licensing.

In connection with the above, the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”) issued FAQs regarding the New Iran E.O., and updated certain existing Iran sanctions-related FAQs.

 

CFTC Chair Evaluates Challenges Facing Derivatives Market

CFTC Chair J. Christopher Giancarlo assessed the challenges facing the CFTC and the United States in the global competition as a center for the derivatives markets. In an address at the West Texas Legislative Summit, Mr. Giancarlo warned that the CFTC must be proactive if the United States is to retain its preeminent position in the global financial markets.

Mr. Giancarlo described the significance of the commodity derivatives market and its impact on pricing. He pointed out that even those who do not participate in such markets are still affected and that 90 percent of companies in the Fortune 500 use derivatives to hedge. He highlighted the challenge of global competition, particularly China’s domestic futures market, specifically alluding to the country’s recent opening to international participation, which has “competitive implications” for the United States. To maintain “world leadership,” he said, it is urgent that derivatives markets in the United States maintain “openness, orderliness, and liquidity” to sustain global economic leadership.

Mr. Giancarlo emphasized the importance of establishing a regulatory framework that is “ahead of the curve,” and advocated for the “SMART-REG” approach he first outlined in 2014. This approach, he said, is intended to “solve problems – real problems, not invented ones.”

Mr. Giancarlo asserted that under his leadership, the CFTC has “emphasized greater care and precision in rule drafting, more thorough econometric analysis, and a reduced docket of new rules and regulations to be absorbed by market participants.”

Lofchie Comment: Chairman Giancarlo went beyond a discussion of the derivatives markets to discuss the underlying commodities markets. In explaining the success of the shale revolution in the United States, he described a “combination of American technological innovation, North American geology, U.S. property law, the skilled and entrepreneurial American workforce and our dynamic capitalist economy.” Chairman Giancarlo continues to be a voice of clarity and an educator in an often confused debate about the value of markets and the limits of governments as providers of services and products.

It is not so long ago that the Union of Soviet Socialist Republics collapsed in economic failure. That collapse seemed as if it would put an end to any debate as to the benefits of government ownership of the means of production. But today that debate is revived, or at least there are new advocates for it. To the extent that these advocates are taken seriously, it is important that advocates for private enterprise and for market competition not be shy to point out successes, face criticisms and to make comparisons as to the successes of different systems.

UK-US Financial Regulation: The Benefits of Greater Coherence

“UK-US Financial Regulation: The Benefits of Greater Coherence” illustrates the importance of “regulatory coherence” across borders.

Authors Ike Brannon, Bob Jennings, and Julie Chon delve into the longstanding and seminal UK and US relationship from a financial regulatory perspective.  They examine pathways to deepen and formalize cooperation with the aim to strengthen the international financial system.

As always, comments, critique, complement, or alternative thoughts are eagerly sought.

View the paper.
http://www.centerforfinancialstability.org/research/US_UK_Regulatory_Coherence.pdf

Fed Balance Sheet Since 1914

Kurt Schuler (CFS senior fellow in financial history) and students of Steve Hanke (CFS special counselor) converted the Fed’s weekly balance sheet from its beginning into spreadsheet form.

The data should prove useful for anyone concerned with the quantitative study of monetary policy in the United States over the last 100+ years.

Our joint Johns Hopkins / CFS working paper, “The Federal Reserve System’s Weekly Balance Sheet since 1914,” is available here.

Accompanying Spreadsheets

Similarly, Bank of England’s Ryland Thomas informs of an improved balance sheet dataset for the Bank and new paper “The Bank of England as lender of last resort: new historical evidence from daily transactional data.”