The Federal Reserve Board’s (“FRB”) “clean holding company” requirements – which apply to the eight U.S. globally systemically important banks and the U.S. intermediate holding companies of the largest foreign banks operating in the United States – became effective on January 1, 2019. The requirements are applicable only to the legal entity that is the top-tier U.S. holding company and do not apply to its affiliates or subsidiaries.
According to the final rule adopted by the FRB, covered holding companies generally are barred from:
- issuing guarantees of a subsidiary’s liabilities with cross-default rights regarding the covered holding company’s insolvency/resolution;
- entering into qualified financial contracts with a third party;
- providing short-term debt instruments to a third party; and
- participating in upstream guarantees.
The prohibitions are applicable only to instruments or arrangements issued or entered into on or after January 1, 2019.
CFTC Commissioner Brian Quintenz described the role of derivatives in supporting economic growth, the advantages of the “principles-based” regulatory model of the U.S. derivatives markets and concrete steps China has taken to liberalize its financial markets.
In remarks at the 14th Annual China International Derivatives Forum, Mr. Quintenz disagreed with the label that derivatives are “risky,” stating that the derivatives present tools to manage and efficiently transfer risk to market participants who have the ability to bear it. He described derivatives as being vital to the “health and growth of a country’s real economy” and said that, as China’s derivatives markets grow, it should adopt an approach to futures market regulation akin to that taken by the CFTC.
He stated that participant diversity, customer protection, and market integrity promoted by principles-based regulation are three characteristics of the U.S. futures market that have contributed to “resiliency, vitality, and efficiency.” In particular, Mr. Quintenz added that:
- the policy of open participation helped increase liquidity, which enables companies to engage with the market even during times of instability;
- the legal regime supporting the U.S. futures markets leads to strong customer protections (i.e., the CFTC and exchanges “police the markets for fraud, abuse and manipulation”); and
- a “principles-based approach” has numerous advantages over a “prescriptive approach” (i.e., principles-based regulation enables market participants to be “individually responsive to market dynamics”).
Mr. Quintenz explained that the growth of China’s futures markets has been critical to its economic rise. In particular, he cited recent incremental steps that have lowered barriers on the ability of non-Chinese entities to access Chinese financial markets.
CFTC Commissioner Brian Quintenz expressed support for an approach toward substituted compliance determinations that distinguishes between the rules designed to address systemic risk reforms and those designed to address market activities. The approach is consistent with an alternative cross-border swaps framework espoused by CFTC Chair J. Christopher Giancarlo in a recent white paper.
In remarks at FIA Asia 2018, Mr. Quintenz disagreed with recent criticism of the white paper by CFTC Commissioner Rostin Behnam. Mr. Behnam argued that Mr. Giancarlo should have expressed his views through formal, statutory procedures, as opposed to a white paper. Mr. Quintenz stated that the majority of CFTC Commissioners will “find a consensus on restructuring the agency’s cross-border approach in the coming months.”
Among other things, Mr. Quintenz supports:
- an approach toward substituted compliance determinations that distinguishes between the rules designed to address systemic risk reforms and those designed to address market activities;
- expanding the use of exemptive authority for non-U.S. central counterparties (“CCPs”) that do not pose risks to the U.S. financial system, while CCPs posing a risk to the U.S. financial system should continue to be registered with the CFTC;
- the proposition that swaps trading venues subject to comparable regulation abroad should be exempt from swap execution facility (“SEF”) registration with the CFTC;
- the proposition that U.S. persons should be permitted to access non-U.S. platforms in non-comparable jurisdictions without SEF registration “subject to materiality threshold”; and
- Mr. Giancarlo’s approach to which transactions count for purposes of the swap dealer thresholds, noting in particular that “foreign consolidated subsidiaries” need only count their dealing activity with U.S. and U.S.-guaranteed persons (rather than all transactions).
Mr. Quintenz also considered “arranged, negotiated and executed” (“ANE”) transactions. Mr. Quintenz said that it is a “credible proposition” that involvement of U.S. personnel in a trade should implicate some U.S.-based regulations. He urged the CFTC to consider whether its supervisory interest in a trade outweighs that of a non-U.S. regulator who has oversight of the counterparties. Mr. Quintenz advocated an ANE standard that focuses on client-facing sales and trading activity, rather than “incidental activity by U.S. personnel.” He also said that any ANE standard must provide market participants with clarity with respect to which regulations will apply to swap transactions from the outset.
Lofchie Comment: While it would be a wonderful thing if the SEC and the CFTC could reach full agreement on a (sensible) cross-border regulatory approach, there are a few issues on which such agreement is particularly important to decreasing regulatory complexity: the definition of U.S. (non-U.S.) person; the situations in which the involvement of a U.S. agent in ANE for a foreign dealer results in the imposition of U.S. legal requirements; and just what U.S. legal requirements are imposed as a result of the U.S. agent’s involvement.
I had the pleasure of presenting “Central Banking East and West since the Crisis,” at a discussion hosted by the Shanghai Development Research Foundation (SDRF) and Friedrich Ebert Stiftung.
Key takeaways include:
- Much has changed in China and central banking in the last decade.
- Most analysis of central bank balance sheets fails to incorporate the impact of the People’s Bank of China (PBOC) on the provision of global liquidity. This is a critical error – especially as the Chinese yuan (CNY) moves toward reserve currency status.
- The Federal Reserve, PBOC, Bank of Japan, and Bank of England were early providers of global liquidity in the aftermath of the crisis. Yet, after 2011, central bank liquidity created distortions.
- Extraordinary monetary policies were far from costless.
- Analysis of speculative activity in futures markets after large injections of central bank liquidity reveals that:
- Speculative activity skyrockets.
- Net speculative long positions increase and push valuations upward.
- The volatility of investor positioning or investor switching behavior also increases.
- Removal of excess central bank liquidity remains one of the most formidable challenges for markets today.
For slides accompanying the presentation: www.CenterforFinancialStability.org/speeches/ShanghaiDRF_101518.pdf
On a parenthetical note, after over two decades of travel to China, this was one of my most extraordinary visits.
SEC Commissioner Hester M. Peirce offered recommendations to regulators on implementing G20 swaps reforms. Ms. Peirce said that the G20 reforms were not foolproof and encouraged regulators to exercise “healthy skepticism” when implementing them.
In remarks before the International Regulators Conference, Ms. Peirce said that “poorly designed regulations” played a role in the 2007-2009 financial crisis. She cited the “favorable regulatory treatment given to highly rated securitization tranches.” She stated that, among other things:
- “central clearing is not a panacea” and brings its own risks;
- regulators should attend to market feedback and market professionals’ knowledge when considering rulemaking; and
- regulators must consider more flexible regulation rather than a one-size-fits-all approach.
In implementing the regulatory framework for security-based swaps, Ms. Peirce advised, the SEC should:
- reexamine proposed and final regulations to ensure that the regulatory framework serves its intended purpose;
- devise clear rules and provide guidance instead of relying on staff no-action letters;
- streamline regulatory processes so that the agency can promptly respond when implementation issues arise;
- ensure that the compliance periods for rules provide the market with sufficient time to prepare for and then comply with requirements; and
- provide that multiple rule sets do not overly burden market participants.
In addition, Ms. Peirce advocated for regulatory cross-border deference as international regulators develop their framework for security-based swaps. According to Ms. Peirce, regulatory cross-border deference will ensure that the global over-the-counter derivatives market can serve the risk management needs of companies throughout economies.
Lofchie Comment: Commissioner Peirce’s call for the regulators to be self-critical is welcome. Likewise are her suggestions that both the causes of the financial crisis and the regulatory responses to it be critically re-examined.
There are, however, important challenges to her stated goals. Is it possible to have multiple regulators both be open to ongoing regulatory review and revision and, at the same time, to conform their own rules? It is certainly good news that the CFTC and the SEC are cooperating now; but will the agencies be able to sustain such cooperation over the long term?
CFTC Commissioner Rostin Behnam advocated for international regulatory cooperation to address the risks posed by benchmark reforms, margin, Brexit, cross-border regulation and FinTech. In a speech at the 2018 ISDA Annual Japan Conference, Mr. Benham weighed in on the following:
- Benchmark Reforms. Mr. Behnam emphasized the importance for global regulatory authorities to work with one another as well as private sector entities to facilitate the transition away from various inter-bank offer rates. He praised the work being done by, among others, the UK FCA, Japanese regulators, and, in the United States, the public-private partnership of the Alternative Reference Rates Committee (“ARRC”). Mr. Behnam encouraged market participants to examine LIBOR-fallback language in existing contracts and highlighted the work of market participants and regulators to develop alternative contract language to facilitate this approach. He also broadly encouraged participants to transact in SOFR-referenced derivatives markets, noting that a move to SOFR could help avoid the consequences of “zombie LIBOR.” Mr. Behnam noted that, while he is aware of “some preference” for continuing with LIBOR, regulators are generally “anticipating a clear and certain break from LIBOR.” He also highlighted the work of the CFTC Market Risk Advisory Committee, in particular its Interest Rate Benchmark Reform Subcommittee. He expressed his hope that the subcommittee would “complement” the work of the ARRC.
- Initial Margin. Mr. Behnam stated that the full phase-in of initial margin requirements in 2020 raises “a number of potential challenges for the marketplace.” He stressed that the CFTC and U.S. bank regulators are listening to concerns of market participants about 2020 implementation and are gathering information to understand the situation to “avoid catastrophe.” He highlighted the work and recommendations of, among others, ISDA and SIFMA, and while not committing to their suggested approach, said that the CFTC and other regulators would “bundle” efforts toward “appropriate recommendations and guidance.”
- Cross-Border Regulation. Mr. Behnam said that CFTC Chair J. Christopher Giancarlo’s recent whitepaper announcing his vision of the agency’s approach to applying its statutory authority over swaps activities to cross-border activities merely reflected his ambitions and views. Mr. Behnam distanced himself from the white paper, stating that he thinks the CFTC should build its internal consensus in accordance with formal, statutory procedures while considering the needs of and affording deference towards global regulators. He noted that the timing for turning the white paper proposals into formal rulemaking is “unclear,” and noted that Mr. Giancarlo had suggested that it would be “several quarters” for such a sea change to progress. Mr. Behnam said that the sufficient time was needed, expressing his view that aspects of Mr. Giancarlo’s proposals would depart from CFTC policy and “may even conflict with our governing statute and prior [CFTC] interpretations thereof or lead to gaps in certain protections afforded to U.S. persons transacting overseas.”
- FinTech. Mr. Behnam urged regulators to approach FinTech with “an open mind and a healthy respect for [regulators’] role in the markets.”
Lofchie Comment: Commissioner Benham’s remarks included some pointed criticisms of CFTC Chair Giancarlo. In reference to the White Paper that Chair Giancarlo published on cross-border regulation, Mr. Benham asserted that CFTC commissioners ought to act only through formal commission action, such as the issuance of concept releases or formal rule makings.
There is nothing in the law that limits the ability of CFTC commissioners to take individual public stands on regulatory issues. If it were improper for a CFTC Commissioner to express a personal view, then it would be not only improper to publish a White Paper, but also improper for a commissioner to deliver a speech or other public statement that has not been ratified by the entire commission. Both Commissioner Benham’s speech and Chair Giancarlo’s White Paper present the standard disclaimer that the views expressed are those of the author and not the views of the Commission or staff.
Financial regulation benefits tremendously from debates about policy that are backed by views as to market behavior and facts. Commissioner Benham’s disagreement with Chair Giancarlo approach ought to focus on the substance of the Chair’s well considered views, and not with its existence.
CFTC Chair Christopher J. Giancarlo proposed an alternative cross-border swaps framework to “better balance systemic risk mitigation with healthy swaps market activity in support of broad-based economic growth.”
In a new white paper, he previewed weeks ago, Mr. Giancarlo outlined his views on the current CFTC approach to regulating cross-border activities and suggested a new approach that would encourage greater cooperation with non-U.S. jurisdictions. Mr. Giancarlo recommended, among other things:
- Non-U.S. Central Clearing Parties (“CCPs”): expanding the use of the CFTC’s exemptive authority for non-U.S. CCPs that are subject to similar regulations in their home country and do not pose risk to the U.S. financial system;
- Non-U.S. trading venues: terminating the bifurcation of the global swaps market into separate U.S. person and non-U.S. person marketplaces by exempting non-U.S. trading venues, in regulatory jurisdictions that have adopted similar G20 swaps reform, from having to register with the CFTC as swap execution facilities;
- Non-U.S. swap dealers: regulating non-U.S. swap dealers whose swap-dealing activity poses a material risk to the U.S. financial system;
- Clearing and trade execution requirements: allowing non-U.S. persons to rely on substituted compliance as to swap clearing and trade execution requirements in comparable jurisdictions; and
- Arrange, negotiate, or execute swap transactions: taking a “territorial approach to the U.S. swaps trading activity,” as non-incidental swaps trading activity in the United States should be subject to U.S. swaps trading rules.
Lofchie Comment: Market participants should be aware that while Chair Giancarlo is, in many respects, advocating for less U.S. regulation, and more deferences to home country regulators, he is not advocating for a deregulatory approach. In fact, in a number of regards, he would expand the scope of U.S. swaps regulation, perhaps most significantly as to swaps that are “arranged, negotiated or executed” in the United States by non-U.S. swap dealers. It is not clear what additional steps he would take in regard to the regulation of non-U.S. swap dealers whose activity pose a material risk to the U.S. financial system (or by what criteria he would determine which swap dealers posed such a risk).
Beyond the substance of what Chair Giancarlo is proposing, what is really fascinating is the manner in which he is pushing the direction of the CFTC, and how he prepared for that push even while being a Commissioner in the minority party; that is, through the publication of white papers, he has established himself as an intellectual and thought leader for the direction of regulation. This has not only established his acumen – he has also freed himself from the constraints of the bureaucratic process. There are probably not too many other regulators who would be able to exert influence in this manner, but one possibility is SEC Commissioner Peirce.
CFTC Chair J. Christopher Giancarlo called on European Union (“EU”) regulators to “commit to an equivalence determination process that focuses on achieving comparable regulatory outcomes and not rule-by-rule exactitude.” In a speech at the Eurofi Financial Forum, Mr. Giancarlo highlighted the importance of U.S. deference toward non-U.S. regulators as to their control over markets and market participants within their jurisdiction; he called on EU policymakers and regulators to adopt a similarly deferential approach to the cross-border application of European swaps regulation to U.S. markets and market participants.
Mr. Giancarlo previewed a forthcoming white paper that will offer recommendations on the application of the agency’s swap rules to cross-border activities. He criticized current EU legislative proposals that raise doubts with respect to the continuance of the policy of cross-border deference and cautioned that failing to adopt an approach of cross-border deference would “turn [global regulation] down that very different path of overlapping and confounding cross-border regulation with its high regulatory cost and constraints on economic growth.”
Lofchie Comment: When he was the CFTC’s Chair, Mr. Gensler asserted that the United States would adopt rules governing the global derivatives markets and market participants, and that Europe would just have to accept that reality. Europe didn’t. Asia didn’t. Joint Cautionary Letter from the EU, France, Japan and the UK to the CFTC on U.S. Cross-Border Swaps Regulation (with Lofchie Comment). Mr. Gensler was being very aggressive. The hand he played was not helped by the fact that the CFTC’s regulations were not so great. The rest of the world responded with a collective no thanks.
Current CFTC Chair Giancarlo is reversing course. It does not make sense for the CFTC to attempt to regulate European and Asian markets. But how will Europe react? Chair Giancarlo suggests that, however Europe acts, the United States will respond in kind.
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.
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.