SEC Acting Chair Michael Piwowar Encourages “Special Study” of Securities Market Reform

A “Special Study” of the securities markets will offer recommendations for financial market regulatory reform. In a speech at the Program in the Law and Economics of Capital Markets at the Columbia University Law and Business Schools, SEC Acting Chair Michael Piwowar called the planned analysis “comprehensive” and “long overdue.”

Columbia University spokespersons disclosed that the Special Study will be conducted in three phases: (i) the commissioning of major papers to provide a “roadmap” for the implementation of the study, (ii) a plan of action for completion of the study, and (iii) the implementation itself, including a comprehensive final report directed at federal financial regulators and the U.S. Congress. The final report has a target completion date of December 2020.

SEC Acting Chair Michael Piwowar applauded the new Special Study, and noted that the 1963 study on which it is based remains “the most comprehensive review of our securities markets that has ever been undertaken.” He urged those who will conduct the new study to approach it with open minds, particularly when identifying entirely new issues and alternatives, and to avoid tethering the project to previous market reform proposals and approaches.

In his remarks, Acting Chair Piwowar questioned the very process of enacting Dodd-Frank:

“[Dodd-Frank] was enacted before any of the official regulatory inquiries into the cause of the financial crisis had been completed. Rather than respond to acute and identifiable causes of concern, Dodd-Frank foisted upon the SEC several special-interest driven mandates that were far outside the scope of our core mission. These overtly politicized obligations have served to distract the SEC from fundamental issues – not the least of which is evaluating how our rules are actually operating.”

He added that the current “pause” in Dodd-Frank-era rulemaking has allowed the SEC to refocus on equity market structure, and that the results of the Special Study will be an “invaluable contribution to potential market structure reforms.”

Lofchie Comment: While the announcement of a study is not necessarily exciting, it is potentially very significant. For the last eight years, the regulation of the securities industry has been, as Chair Piwowar observes, heavily politicized. Interested legislators have taken the view that more regulation is inherently good, and that less regulation is inherently bad, without considering the actual cost or benefits of any particular item of legislation. If the discussion of appropriate regulation can be made less partisan, then the economy will benefit, particularly if a calmer discussion allows for the presentation of a broader range of views.

Sargen on Healthcare, the Budget, and Tax Reform


  • Economic policies of the Trump Administration are key to assessing the economic and market outlook.  The Republican House tax bill drafted last summer and slated to be voted on later this year has been the focal point for investors. Meanwhile, they are assessing the Republican replacement plan for Obamacare and the 2018 budget proposal submitted by the Office of Management and Budget (OMB) this past week.
  • Both plans are highly controversial, and it remains to be seen what will ultimately be enacted. The proposed budget would fund a 9% increase in military and security spending via steep cutbacks in non-defense related programs that Congressional Democrats and some Republicans oppose.  The main worry for the Republican leadership, however, is that the replacement plan for Obamacare may not attract sufficient Republican support to ensure passage.
  • How these proposals play out could have important consequences for tax reform legislation.  The healthcare plan supported by Speaker Ryan will halt Medicaid expansion in 2020 and shift funding from open-ended entitlements to a per capita cap.  The Congressional Budget Office (CBO) estimates it will generate $1 trillion in savings over a decade, although it will also reduce the number of people receiving insurance substantially.
  • Prospects for enacting tax reform would be enhanced if the Congressional Republicans coalesced on a healthcare plan, whereas failure to reach agreement could jeopardize tax reform and lessen investor confidence.  The vote in the House this week will provide an early read.

Focusing on Economic Policies

One of our main messages for investors since the presidential election has been to focus on policies of the Trump Administration that will have an important bearing on the economy. They are the news that will drive financial markets, as opposed to comments and tweets by the President that many regard as noise.

Until recently, the only substantive policy proposal was the House tax reform bill drafted by the Republican leadership last summer.  It contains features that President Trump supports including: (i) a significant reduction in the corporate tax rate (albeit to 20% instead of the 15%); (ii) immediate expensing of capital outlays but no interest rate deductibility; and (iii) incentives for multinationals to repatriate profits earned abroad.

The most controversial element is the border adjustment tax (BAT) that effectively subsidizes exports and taxes imports of overseas affiliates.  The intent is to eliminate incentives for U.S.-based firms to shift production abroad, and the BAT is also estimated to create more than one trillion dollars in tax revenues over a decade.  The latter is deemed essential by the Republican leadership to ensure tax reform is neutral for the federal budget.

The prospect of significant tax reform combined with regulatory relief, in turn, has been a major driver of the stock market rally since the election.  Indeed, some surveys indicate that approximately 70% of those polled believe legislation will be passed later this year.  The principal uncertainty is whether the BAT provision will clear the final bill.  If not, prospects for the budget deficit expanding considerably are higher, as it will be difficult to make up the loss in revenues.

Beyond this, investors suspect the budget deficit is set to widen during the Trump Administration for the following reasons: (i) President Trump supports a large increase in military and security spending as well as a one trillion dollar infrastructure program; (ii) during the campaign he indicated he would not touch entitlement programs such as Social Security, Medicare, and Medicaid; and (iii)  the President has stated he would help pay for these programs by making large scale cuts in other discretionary spending; collectively, however, they account for only 15% of total federal spending.

With the House Republican leaders recently having drafted legislation to replace Obamacare and the Office of Management and Budget submitting its plan for discretionary spending in the coming fiscal year, investors are now examining details of both plans and assessing the prospects they will be enacted.

Linking OMB’s Budget Plan and the Republican Health Care Bill

The budget plan submitted by OMB and the Republican bill to replace Obamacare were submitted separately; consequently, they have each drawn considerable scrutiny.  To understand them better, however, it is important to recognize that both are key components of the FY2018 budget plan that will be enacted later this year.

The plan submitted by OMB last week, for example, applies only to discretionary federal spending, which represents about 30% of total federal spending.  Under the OMB proposal, military and security outlays would increase by 9% in FY2018, and would be funded entirely through cutbacks in other programs, of which the largest would be for social programs and the EPA.  However, because Democrats and some Republicans are staunchly opposed to large-scale cutbacks in non-defense spending, the OMB plan is widely perceived to be an opening move by the Trump Administration that lays out its priorities.

The main areas of spending that are not addressed in the OMB proposal are mandatory programs, which consist of entitlements (Social Security, Medicare and Medicaid) and net interest payments on the national debt.  Of these, the fastest growing segment is Medicaid, which was expanded as part of the Affordable Care Act (ACA) and resulted in the largest gain in insurance coverage, about 11 million people.  As currently constituted, it is an open-ended obligation of the federal government.

Robert Samuelson of The Washington Post observes (March 20, 2017) that Medicaid increasingly is another mechanism by which government skews spending toward the old and away from the young: “Although three-quarters of Medicaid recipients are either children or young adults, they account for only one third of costs.  The elderly and disabled constitute the other one-quarter of recipients, but they represent two-thirds of costs.”  Samuelson concludes that getting Medicaid costs under control is a much needed reform, considering the aging of the population, with the number of Americans 85 and older expected to increase by 50% by 2030.

This is where the Republican Health Care bill comes into play, as one of the key provisions is phasing out Medicaid expansion through 2020.  Under the Republican bill the program also transitions to a system of block grants to each state that is based on per-capita payments for the Medicaid population.  According to the Congressional Budget Office (CBO), the Republican bill cuts spending by $1.2 trillion net and it eliminates new taxes worth just shy of $900 billion through 2026, of which the vast saving is from reduced Medicare expense.

That’s the good news. The bad news is the cost saving is attributable to fewer people enrolling for medical insurance: CBO estimates there will be a decline of 14 million enrollees next year relative to the Obamacare tally and a cumulative decline of 24 million by 2026.  Even if the CBO estimates prove to be too high, they pose a political problem for the Republican leadership in Congress, who must bring the conservative wing of the Party that favors a quicker end to Medicaid expansion into the fold together with moderates in the Senate who are concerned about a voter backlash if coverage is diminished.

At this juncture, it is unclear whether the Republicans in Congress will be able to find an acceptable compromise.  The first clear indication will come this week when a voted is slated in the House of Representatives.  While conservatives favor an earlier end to Medicaid expansion or simply repealing the ACA, such action would still leave in place the expensive open-ended federal Medicaid commitment.

Thus far, President Trump has been supporting Speaker Ryan’s plan, but he could switch tactics if passage of the bill appears in trouble.  Also, if the President continues to back the plan, he will be criticized for breaking his campaign pledge of not touching entitlements and his assurance that no one will lose coverage under the Republican plan.

Implications for Tax Reform

The resolution of the Health Care bill not only matters for healthcare spending, which comprises 28% of total federal outlays, but also for the passage of tax reform.  If the Congressional Republicans are able to coalesce around a healthcare bill that can pass Congress, it bodes well for the passage of tax reform legislation that investors are counting on.

Conversely, should Republicans be unable to agree, it would damage the chances for meaningful tax reform and harm their chances for maintaining control of Congress in the 2018 elections.  Daniel Henninger of the Wall Street Journal (March 10, 2017) characterizes the Republican dilemma as follows:

            “The day the Republicans clutch on this (healthcare) reform, there will be six-column headlines across the Washington Post and New York Times: “Trump Abandons Promises on Health Care”

            “It will be a fast ride downhill from there. That is because the health-care reform bill is inextricably linked to the politics of tax reform, the second pillar of the Trump legislative agenda.”

The challenge of confronting entitlement program expansions is particularly formidable now, as the aging of the baby boomers implies a steady increase in the size of the federal budget deficit in coming decades absent any changes in current policies (see Figure 1).  Indeed, by 2025 people 65 years and older will comprise 20% of the total population.  Meanwhile, with the added pressure to increase military and infrastructure spending the inevitable question investors must ask is “who will pay the bills?”  Once market participants understand the nature of the fiscal predicament, investors may reassess the optimistic assumptions that are embedded in financial markets today.

Figure 1: CBO Projections of Federal Budget Deficit Assuming No Change in Policies  

Source: Congressional Budget Office.

Acting Chair Giancarlo Asserts “New Direction Forward” for CFTC

CFTC Acting Chair J. Christopher Giancarlo called for the CFTC to “reinterpret its regulatory mission” by (i) fostering economic growth, (ii) enhancing U.S. financial markets, and (iii) “right-sizing its regulatory footprint.” Acting Chair Giancarlo delivered his remarks before the 42nd Annual International Futures Industry Conference, on the day after President Donald J. Trump announced his intention to nominate Mr. Giancarlo as CFTC Chair (see previous coverage).

In his speech, Mr. Giancarlo called for an end to the “overly prescriptive regulation of the American derivatives markets,” which he asserted are now “more fragmented, more concentrated, less liquid, and less supportive of economic growth and renewal than in the past.” Mr. Giancarlo noted that he is not opposed to Title VII of Dodd-Frank (in which, he maintained, “Congress got much right”), but rather with the CFTC’s implementation of the market reforms.

Acting Chair Giancarlo stated that the CFTC should foster economic growth by:

  • reducing regulatory burdens through initiatives like “Project KISS” (“Keep It Simple, Stupid”), designating his chief of staff as the CFTC Regulatory Reform Officer, and reviewing all CFTC rules in order to reduce regulatory burdens and costs for participants in markets under CFTC oversight;
  • becoming a “smarter regulator” by restructuring agency surveillance organizations and appointing a Chief Market Intelligence Officer who will report directly to the CFTC Chair; and
  • embracing financial technology (“fintech”) by adopting a “do-no-harm” approach and reviewing agency treatment of fintech innovation.

Acting Chair Giancarlo also asserted that the CFTC should enhance financial markets by:

  • “calibrating bank capital charges for economic growth” as a voting member of the Financial Stability Oversight Committee;
  • reforming the CFTC’s “flawed swaps trading implementation” with a “better regulatory framework for swaps trading” that allows market participants to select the manner of trade execution best suited to their needs, rather than having specific types “chosen for them by the federal government”; and
  • improving coordination with global regulators through measures while “fully embrac[ing] the Trump Administration’s Executive Order to advance American interests in international financial regulatory negotiations and meetings.”

Lastly, Mr. Giancarlo suggested that the CFTC should obtain a “right-size regulatory footprint” by:

  • “normaliz[ing] CFTC operations” after the “era of Dodd-Frank implementation” by decreasing regulatory burdens and attending to “longer range goals,” such as leveraging diversity;
  • “eschew[ing] empire building” at the CFTC by “resetting its focus on its core mission” and streamlining the work of various divisions; and
  • “run[ning] a tighter ship” in the wake of recent reductions in the agency budget and appropriations.

Acting Chair Giancarlo concluded:

“The time has come to reduce regulatory barriers to economic growth. The American people have elected President Trump to turn the tide of over-regulation. Financial market regulators, like the CFTC, must pursue their missions to foster open, transparent, competitive and financially sound markets in ways that best foster American prosperity.”

Trump Administration Budget Resets Priorities

The Office of Management and Budget (“OMB”) released the Trump Administration 2018 Budget Plan (“America First: A Budget Blueprint to Make America Great Again“). The Plan focuses on “reprioritiz[ing] Federal spending so that it advances the safety and security of the American people.”

The Budget Plan does not specify how much money would be allocated to independent agencies such as the SEC and the CFTC. With regard to the U.S. Treasury Department, the planned budget prioritizes (i) preserving the operations of the IRS that are intended to prevent fraud, (ii) reducing spending on “paper-based” reviews, (iii) strengthening cybersecurity, and (iv) eliminating funding for community development financial institutions. Overall, there are dramatic cuts in spending which would reduce the Federal workforce.

The Budget Plan also emphasizes “three significant steps” the Trump administration has already taken to eliminate “unnecessary and wasteful regulations,” including (i) the January 20, 2017 “Regulatory Freeze” memorandum (see previous coverage), (ii) the “Reducing Regulation and Controlling Regulatory Costs” Executive Order (see previous coverage) and (iii) the “Enforcing Regulatory Reform Agenda” Executive Order (see previous coverage).

Lofchie Comment: Taken as a whole, the budget reflects significant decision-making and policy choices, as opposed to incrementalism. It is a budget created by a business person who is deciding that certain priorities are important (and should get more money) and that other activities are just not working (and so should be eliminated, as opposed to growing at a rate slower than inflation).

While the budget moves massive amounts of planned government spending, it holds the total amount of government spending constant. Psychologically, this emphasizes the fact that making a budget is about choices; deciding where money is to be spent is of one piece with deciding where money should not be spent (money not being unlimited). This flatline in overall expenditure now puts the burden on opponents of the planned budget to be explicit as to their priorities: if they want to increase spending on one activity, then they must also declare where they wish to decrease spending. Now let the (thoughtful, high-minded, respectful) debate about spending priorities begin.

Trump Administration Endorses Congressional Resolutions to Nullify DOL Savings Arrangement Rules

The White House endorsed Congressional resolutions of disapproval that would nullify two Department of Labor (“DOL”) rules (“Savings Arrangements Established by States for Non-Governmental Employees” and “Savings Arrangements Established by Qualified State Political Subdivisions for Non-Governmental Employees“). The two DOL rules set forth requirements by which states could establish state payroll deduction savings programs for private-sector employees without causing the states or private-sector employers to establish “employee pension benefit plans” or “pension plans” under ERISA. The White House’s statement indicated that the DOL rules allowed a “new type of State-based retirement plan that would lack important Federal protections, and they would give a competitive advantage to these public plans.”

Lofchie Comment: In effect, the Department of Labor under the Obama administration permitted state governments to go into the business of providing financial services to non-governmental employees, but without being subject to the same requirements as would apply to private financial institutions providing financial services. It appears that the Trump administration will likely withdraw that permission.

This seems a positive “pro-regulatory” action by the Trump administration. There does not seem to be any policy reason why the government should provide services that had been heavily regulated when offered by private enterprise, but unregulated when offered by a governmental entity. Governmental entities are subject to conflicts of interest, too, and should be subject to the same duties of loyalty and care as private businesses. To put it differently, there is no reason to think that governmental entities require less oversight than private businesses.

President Trump to Nominate Giancarlo as CFTC Chair, Announces Other Key Appointments

President Trump announced his intent to nominate J. Christopher Giancarlo as CFTC Chair. Seven other upcoming nominations were also announced: James Donovan as Deputy Secretary of the Treasury; Eric D. Hargan as Deputy Secretary of Health and Human Services; Adam Lerrick as Deputy Secretary of the Treasury; Andrew K. Maloney as Deputy Under Secretary of the Treasury; David Malpass as Under Secretary of the Treasury for International Affairs; Sigal Mandelker as Under Secretary of the Treasury for Terrorism and Financial Intelligence; and Brent James McIntosh as General Counsel for the Department of the Treasury.

House Members Ask Committee to Preserve Tax-Exempt Municipal Bonds

As Congress considers tax reform and infrastructure financing, a bipartisan group of more than 150 Representatives requested that the House Committee on Ways & Means recognize and preserve “the vital role of tax-exempt municipal bonds.”

In a letter addressed to Committee Chairman Kevin Brady and Ranking Member Richard Neal, the Representatives stated:

“Any changes under consideration to the tax-exempt status [of municipal bonds] that would increase the cost of financing for states and local governments should be provided very careful consideration. We believe the current tax-exempt status contributes to efficient economic growth that benefits all Americans.”

Comptroller of the Currency Discusses Regulation of FinTech

In a speech at the LendIt USA 2017 conference, Comptroller of the Currency Thomas J. Curry (i) outlined the function of the Office of the Comptroller of the Currency (“OCC”), (ii) urged financial industry innovators to develop strong compliance programs early on, (iii) described the recently established Office of Innovation as a resource to support banks and financial technology (“FinTech”) companies, and (iv) defended the OCC initiative to grant federal charters for FinTech companies involved in banking activities.

FRB Governor Powell Describes Challenges to Real Time Payment Systems and Blockchain Technology

Federal Reserve System Governor (“FRB”) Jerome Powell described the challenges and policy objectives behind (i) the creation of a real-time retail payment system, (ii) the use of distributed ledger technology for clearing and settlement services, and (iii) the issuance of digital currencies by central banks.

In an address before the Yale Law School Center for the Study of Corporate Law, Governor Powell criticized the sluggishness of the U.S. payment system. He stated: “our traditional bank-centric payments system, sometimes operating on decades-old infrastructure, has adjusted slowly to the evolving demands for greater speed and safety. Innovators have built new systems and services that ride on top of the old rails but with mixed results, and over time, our system has grown more fragmented.” Arguing that “it will take coordinated action to make fundamental and successful nationwide improvements,” Mr. Powell said that efficiency and safety were the FRB’s primary objectives regarding the development of a faster payment system utilizing real-time payments (see FRB Policy on Payment System Risk). Mr. Powell highlighted some of the work being done by the FRB Faster Payments Task Force, which recently completed reviews of 19 faster payment proposals.

On the use of DLT and blockchain technology, Mr. Powell noted recent developments and collaborations between banks and market infrastructures, including plans to use DLT by a few major U.S. clearing organizations. However, Mr. Powell observed that:

  • the financial industry has focused on the development of systems that require permission for access to ledgers, functions or information, rather than the open access system contemplated by Bitcoin;
  • firms are still trying to determine the business case for upgrading and streamlining payment, clearing, settlement, and other functions related to DLT;
  • technical issues – including issues of reliability, scalability, and security – remain unresolved;
  • governance and risk management will be “critical” to the success of DLT; and
  • the legal foundations supporting DLT, including jurisdictional issues, need more attention.

Mr. Powell also discussed the prospect of central banks issuing digital currencies. He cautioned that major technical and privacy challenges, as well as competition with private-sector products, might “stifle innovation over the long run.”

New Trucking Futures and Options Exchange to Launch

Risk Desk editor John R. Sodergreen interviewed former ICE eConfirm Chief Bruce Tupper and former CFTC attorney Peter Kavounas about the prospective launch of a trucking futures and options exchange. The new exchange, TransVix, is intended to serve the risk management needs of the trucking industry.

Mr. Tupper explained that the trucking market involves a limited number of pre-set routes, or “origin-destination” pairs, with seasonality data trends resembling those of the gas pipeline network and also similar in concept to the electricity market. He stated that the trucking market has “a perishable commodity, one you can’t really store and [one that] has so many potentially precipitous impacts” that are difficult to predict and hedge against. He said that the trucking industry experiences greater price volatility than the energy markets because “shippers here can move a lot of their fleet into a market that might be overpriced at the moment, and take advantage of those rates, then bring it back down.” Mr. Tupper also predicted that there “should be a very good spot market from the beginning” and said that TransVix eventually “will offer an 18-month curve to capture a year’s worth of seasonality.”

In addition, Mr. Tupper mentioned that TransVix intends to partner “with an established clearing operation to bring these contracts to market.”