SEC Deputy Director Grim Discusses Division of Investment Management Initiatives

At the 5th Annual DCIIA Public Policy Forum, SEC Deputy Director David Grim delivered remarks on the initiatives of the Division of Investment Management (“IM”) regarding target date funds, money market fund reform, the variable annuity summary prospectus, the investment adviser and broker-dealer initiative, and the rollover of retirement plan assets.

Director Grim stated that target date funds are a “prime example of industry innovation developed to meet the incredibly important and shifting challenge of retirement stability to American investors.” In 2010, the SEC proposed rules regarding target date funds to address concerns about investors’ understanding of those funds and, in 2013, the Investor Advisory Committee submitted a set of findings and recommendations relating to target date funds. In response, Director Grim stated that the Division of IM’s staff is currently preparing a request soliciting additional comments on a standardized risk-based glide path illustration for target date funds.

Regarding money market fund reform, Director Grim mentioned that, along with the first set of reforms in 2010, the SEC proposed additional reforms in June 2013 that were designed to “lessen money market funds’ susceptibility to heavy redemptions, improve their ability to manage and mitigate potential contagion from high levels of redemptions, and increase the transparency of their risks” while preserving their benefits. The proposal included two principal alternative reforms: (i) a floating NAV and (ii) allowance of the use of liquidity fees and redemption gates in times of stress. Director Grim stated that the staff is currently reviewing comment letters on the proposal, noting that adopting final rules on money market mutual funds is a critical priority for the SEC in 2014.

Director Grim also mentioned that the Division of IM is working on potential reforms to variable annuity disclosure. Even so, he noted, it is a challenge to boil down long and complex disclosure about variable annuities into the key facts that investors need to know about the limitations, costs and benefits of investments.

Additionally, he explained, Chair White has directed the staff to evaluate potential options available to the SEC regarding the investment adviser and broker-dealer initiative, including a uniform fiduciary standard for broker-dealers and investment advisers when dealing with retail customers, as well as other measures.

Director Grim briefly mentioned that colleagues in the OICE National Exam Program have indicated that, in keeping with their examination priorities for 2014, they will undertake initiatives related to the rollover of retirement plan assets.

See: Director Grim’s Speech.

 

SEC Issues Staff Analysis of Data and Academic Literature Related to MMF Reform

The SEC staff of the Division of Economic and Risk Analysis published analyses of data and academic literature related to money market fund (“MMF”) reform.  The analyses, which are available for review and comment, examine:

  • the spread between same-day buy-and-sell transaction prices for certain corporate bonds from January 2, 2008, to January 31, 2009;
  • the extent of government MMF exposure to nongovernment securities;
  • academic literature reviewing recent evidence on the availability of “safe assets” in the U.S. and global economies; and
  • the extent to which various types of MMFs are holding in their portfolios’ guarantees and demand features from a single institution.

Comments on this supplemental information may be submitted to the SEC under the comment file for rule amendments that the SEC proposed in June 2013 regarding MMF reform.  Comments should be received by April 23, 2014. 

See:  SEC Press Release; Analysis of Liquidity Cost During Crisis Period; Analysis of Government MMF Exposure to Non-Government Securities; Analysis of Municipal MMF Exposure to Parents of Guarantors; Analysis of Demand and Supply of Safe Assets in the Economy
Related news:  SEC Proposes Money Market Fund Reforms (June 7, 2013); SEC Proposes in the Federal Register Money Market Fund Reform and Amendments to Form PF; Comments Due September 17th (June 20, 2013); Hearing on Money Market Funds (with Summary of the Hearing by Delta Strategy Group) (September 19, 2013); SIFMA Comments on SEC MMF Proposal (September 19, 2013); Investment Company Institute Comments to SEC Regarding Money Market Funds (September 19, 2013).

 

MFA Submits Comments to FSB Regarding Securities Lending and Repo Markets

The MFA has submitted a comment letter to the Financial Stability Board (“FSB”) regarding its consultative document titled “FSB Policy Framework for Addressing Shadowing Banking Risks in Securities Lending Repos.”

In the comment letter, the MFA commended the FSB’s goal of identifying and addressing gaps in regulation, and identifying shadow banking activities that create systemic risk. The MFA encouraged the FSB to carefully consider the types of information that would be most valuable to regulators before designing a new reporting framework. The MFA recommended that the FSB conduct a review of the tri-party custody books at major custodians in order to gain a better understanding of the type of information needed to identify the build-up of systemic risk. With regards to cash collateral reinvestment, rehypothecation of client assets, and collateral valuation management, the MFA recommended that the FSB conduct further analysis to determine the financial impact of the potential new rules.

See: MFA Comment Letter; MFA Press Release.
See also: FSB Policy Framework: “Strengthening Oversight and Regulation of Shadow Banking.”

 

Governor Stein Delivers Speech to FRB Chicago on ”Fire Sales” in Securities Financing Markets

Governor Jeremy C. Stein delivered a speech at the Federal Reserve Bank of Chicago and International Monetary Fund Conference which echoed themes of his previous speeches, focusing on “fire sales” in securities financing transactions and laying out a case for further policy attention to the issue.  As in prior speeches, Governor Stein discussed the welfare economics of fire sales, explaining that a forced sale of an asset is not just an event that leads to prices being driven below long-run fundamental values, but one that involves market failure or externality of the sort that might elicit a regulatory response. He further discussed how securities financing transactions (“SFTs”), such as those done via repurchase agreements, are an object of concern for policymakers since they give way to fire sale externalities (e.g., market costs that may result from problems in these markets).

Governor Stein also assessed the effectiveness of recent regulatory tools, and suggested possible alternative ways to deal with SFT-related fire-sale externalities, such as capital surcharges, modified liquidity regulation, and universal margin requirements.

In closing, Governor Stein briefly mentioned the risks to the financial system created by money market funds, which he essentially described as operating as banks with no capital.

See: Governor Stein’s Speech at FRB Chicago.  
Related News: FRB Governor Stein’s Speech at FRB on ”Fire Sales” in Securities Financing Markets (October 7, 2013).

Hearing on Money Market Funds (with Summary of the Hearing by Delta Strategy Group)

The House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises held a hearing titled, “Examining the SEC’s Money Market Fund Rule Proposal.” The hearing focused on the Securities and Exchange Commission’s (“SEC”) June 5, 2013, rule proposal to reform the regulation of money market mutual funds (“MMMFs”). The proposal focuses on three options: a floating net asset value (“NAV”) for institutional prime funds, the adoption of a “fees and gates” alternative, or a combination of the two.

The following witnesses testified:

  • The Honorable Steven N. McCoy, Treasurer, State of Georgia, on behalf of the National Association of State Treasurers
  • The Honorable Sheila Bair, Chair, Pew Charitable Trusts, Systemic Risk Council
  • Ms. Marie Chandoha, President and Chief Executive Officer, Charles Schwab Investment Management Inc.
  • Mr. James Gilligan, Assistant Treasurer, Great Plains Energy, on behalf of the U.S. Chamber of Commerce
  • Mr. Paul Schott Stevens, President & CEO, Investment Company Institute

See:  Summary of hearing by Delta Strategy Group.
See also: Webcast of hearing; SIFMA Comments on SEC MMF Proposal (September 19, 2013); Investment Company Institute Comments to SEC Regarding Money Market Funds (September 19, 2013); Committee on Financial Services to Examine SEC’s Money Market Fund Rule Proposal (September 17, 2013); SEC Proposes in the Federal Register Money Market Fund Reform and Amendments to Form PF; Comments Due September 17th (June 20, 2013); SEC Proposes Money Market Fund Reforms (June 7, 2013); SEC Open Meeting: Money Market Fund Reform (with link to Delta Strategy Description of SEC Meeting) (June 6, 2013).

Investment Company Institute Comments to SEC Regarding Money Market Funds

The Investment Company Institute (“ICI”) submitted comments regarding the SEC-proposed amendments to the rules and related requirements that govern money market funds (“MMFs”), most notably Investment Company Act Rule 2a-7 (“Money Market Funds”).  The ICI commented on number of topics within the SEC MMF proposals, generally including:

  • agreeing with the SEC that structural reforms to government and tax-exempt MMFs should not be applied;
  • recommending that the SEC expand the circumstances under which a board may impose a liquidity fee or temporarily suspend redemptions to cover situations in which heavy redemptions are already underway or foreseeable;
  • disagreeing with the proposal to require prime and tax-exempt institutional MMFs to let net asset value (“NAV”) float;
  • disagreeing with the proposal to combine floating NAV and liquidity fee/temporary gate proposals;
  • disagreeing with the proposal to eliminate the amortized cost method of valuing securities for all funds;
  • agreeing with the proposal to enhance public disclosure and the reporting of MMF portfolio information and risks, unless the SEC requires MMF NAVs to float; 
  • making multiple suggestions regarding more stringent diversification requirements;
  • disagreeing with the proposal to revise current stress-testing requirements; and
  • making suggestions on the proposed amendments to Form PF reporting requirements.

See: ICI Comment Letter.
See also: Committee on Financial Services to Examine SEC’s Money Market Fund Rule Proposal (September 17, 2013); SEC Proposes in the Federal Register Money Market Fund Reform and Amendments to Form PF; Comments Due September 17th (June 20, 2013); SEC Proposes Money Market Fund Reforms (June 7, 2013); SEC Open Meeting: Money Market Fund Reform (with link to Delta Strategy Description of SEC Meeting) (June 6, 2013).

SIFMA Comments on SEC MMF Proposal

SIFMA submitted comments to the SEC regarding the SEC proposed changes to reform the way money market funds (“MMFs”) operate.  In the comment letter, SIFMA stated their support of the SEC goals to enhance the resiliency of MMFs. However, SIFMA voiced concerns that some elements of the SEC proposal would alter certain indispensable characteristics of MMFs that make them attractive to shareholders, thereby endangering the viability of MMFs as an investment option and vital element of capital formation and credit availability. SIFMA urged the SEC not to impose both the floating net asset value (“NAV”) and the liquidity fee and redemption gate proposals together on any type of MMF, among other recommendations and comments.

See: SIFMA Press Release; SIFMA Comment Letter.
See also: Committee on Financial Services to Examine SEC’s Money Market Fund Rule Proposal (September 17, 2013); SEC Proposes in the Federal Register Money Market Fund Reform and Amendments to Form PF; Comments Due September 17th (June 20, 2013); SEC Proposes Money Market Fund Reforms (June 7, 2013); SEC Open Meeting: Money Market Fund Reform (with link to Delta Strategy Description of SEC Meeting) (June 6, 2013).

Committee on Financial Services to Examine SEC’s Money Market Fund Rule Proposal

The House Financial Services Subcommittee on Capital Markets will hold a hearing to examine the SEC’s rule proposal to further reform the regulation of money market mutual funds (“MMFs”) on Wednesday, September 18.   Among the reforms proposed is a requirement that “prime” MMFs adopt a floating net asset value per share instead of a stable $1.00 share price, as well as a proposal to allow MMF directors to impose liquidity fees and redemption gates in times of stressThe meeting will be a one-panel hearing with five witnesses, including representatives from the National Association of State Treasurers, the Systemic Risk Council and the U.S. Chamber of Commerce. 

See:  Committee Memorandum of the Hearing.
See also:  SEC Proposes in the Federal Register Money Market Fund Reform and Amendments to Form PF; Comments Due September 17th (June 20, 2013); SEC Proposes Money Market Fund Reforms (June 7, 2013); SEC Open Meeting: Money Market Fund Reform (with link to Delta Strategy Description of SEC Meeting) (June 6, 2013).

Industry Groups Submit Critical Comments on CFTC Cross-Border Guidance

SIFMA, the Futures Industry Association (“FIA”), and the Financial Services Roundtable (“FSR”) have submitted comments to the CFTC on the Exemptive Order and the Interpretive Guidance and Policy Statement regarding the regulation of swaps having some cross-border element.

The comments address (i) the lack of an appropriate time period to comply, including certain requirements being effective immediately, making it impossible to comply, (ii) the complexity of the guidance and (iii) the lack of clarity in the guidance.

Lofchie Comment: The numerous problems pointed out by the comment letter demonstrate that the CFTC would have been better off going through the public comment process “mandated” by the Administrative Procedures Act rather than avoiding the APA on the questionable basis that the guidance does not constitute rulemaking.

See: SIFMA Press Release; SIFMA, FIA, and FSR Comments to CFTC.
See also: CFTC Approves Cross-Border Guidance and Exemptive Order (July 15, 2013).

DTCC Releases White Paper on Systemic Risk in Global Securities Industry: “Beyond the Horizon”

The DTCC has issued a white paper identifying a number of developing trends that would impact the industry’s ability to protect itself against unidentified threats to the worldwide financial system.

  • Cyber Security: This issue has emerged as arguably the top systemic threat facing global financial markets and associated infrastructures, including the threat of Distributed Denial of Service attacks, attacks against systems containing transaction records, and risk of disclosure of restricted, confidential or Material Non-Public Information via compromise of internal systems.
  • Impact of New Regulations: The financial industry has expressed concerns that even though the regulations are well-intentioned and necessary, there is a danger that their scope and complexity may actually be creating unintended consequences or an entirely new set of risks.
  • Counterparty Risk: There is still ongoing industry debate as to whether the “too-big-to-fail” issue has been sufficiently resolved. Today, the top U.S. banks still control the vast majority of total assets within the sector and just a few provide some of the most critical services.
  • Collateral Risk: There are growing concerns globally about potential risks associated with a future shortage of high-quality collateral, possible pro-cyclical impacts of collateral requirements, along with operational challenges related to collateral management.
  • Interconnectedness Risk: Inter-linkages among financial firms and infrastructures greatly improve the effectiveness and efficiency of clearance and settlement activities and processes. They also create a complex network of interdependent legal, credit, liquidity, and operational risks. This presents a possible source of systemic risk by increasing the potential for operational and other disruptions to spread quickly and widely through the financial system in a worst-case scenario.
  • CCPs as Single Points of Concentration: More and more business is being forced through central counterparties, including DTCC.
  • Business Continuity Risk: The problems created by Hurricane Sandy are cited as an example.
  • Market Quality: DTCC points to the numerous compliance violations being cited by regulators and increased levels of fines and other penalties, which may be significant enough to drive firms out of business.
  • High-Frequency Trading: While DTCC acknowledges the benefits of the high-frequency trading, it also says that this activity creates technology risks.

Lofchie Comment:  One primary goal of government regulation is to make the financial regulatory safer. The DTCC has identified many issues either created or exacerbated by government actions. For example, (i) the very high fixed costs of complying with Dodd-Frank derivatives rules will knock medium-sized firms out of some of the swaps business, exacerbating concentration in the financial industry, (ii) the rate of change in financial regulation is simply too great for the regulators or firms to be confident that they are not causing further problems; and (iii) the size of the transaction flow that is being pushed through a few clearing corporations and through a small number of FCMs is too large to understand the consequences. The most interesting risk in this regard is what DTCC refers to as “market quality,” or what the industry might refer to as “enforcement risk.” One can make a reasonable case that with so many federal and state regulators – all enthusiastic to bring enforcement actions – the very machinery is less significant as a means to discourage or punish misdeeds, than it is as an independent source of wildcard risk.

See: DTCC White Paper; DTCC Introductory Video.
See also: DTCC Press Release.