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.

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.”

Financial Services Committee Chair Prepares “Views and Estimates” Document for Markup

Financial Services Committee Chair Jeb Hensarling circulated to Members of the Committee on Financial Services a “Views and Estimates” document for markup. Once adopted by the full committee, the document will be transmitted to the Budget Committee “to be set forth in the concurrent resolution on the budget for fiscal year 2018.”

The document is required by section 301(d) of the Congressional Budget Act which requires “each standing committee to submit to the Committee on the Budget, not later than six weeks after the President submits his budget or upon the request of the Budget Committee: (i) its views and estimates with respect to all matters to be set forth in the concurrent resolution on the budget for the ensuing fiscal year that are within its jurisdiction or function; and (ii) an estimate of the total amounts of new budget authority and budget outlays to be provided or authorized in all bills and resolutions within its jurisdiction that it intends to be effective during that fiscal year.”

The document includes the following recommendations:

  • “replace the failed aspects of the Dodd-Frank Act with free-market alternatives”;
  • “place the non-monetary policy activities of the independent agencies within the Committee’s jurisdiction on the appropriations process”;
  • “replac[e] the Orderly Liquidation Authority with established bankruptcy procedures, wherein shareholder and creditor claims are resolved pursuant to the rule of law rather than the arbitrary discretion of regulator”;
  • eliminate the Office of Financial Research, as proposed by the Financial CHOICE Act;
  • “enhance accountability and lead to greater transparency” at the Consumer Financial Protection Bureau (“CFPB”) by reforming the CFPB’s “operations and unconstitutional structure, including by subjecting the CFPB to Congressional appropriations process, and by reforming the CFPB’s statutory mandate to ensure that it takes into account, and seeks to promote, robust market competition”;
  • “modernize the SEC’s operations and structure to eliminate inefficiencies”; and
  • “promote greater accountability at the Federal Reserve by advancing legislation to fund the non-monetary activities of the Federal Reserve’s Board of 33 Governors and 12 regional banks through the Congressional appropriations process.”

Lofchie Comment: If there is an overriding theme in the initiatives contained in the Visions and Estimates document, it is that Congress chooses to assert its authority over the so-called “regulatory state,” or the unofficial fourth branch of the government. Most significantly, Congress is exercising that authority by asserting its funding power over the various regulatory agencies – particularly, the CFPB. Undoubtedly, many of these measures will be seen as reasons for Democrats and Republicans to fight, but that should not be the case with the exercise of the funding powers. The issue raised by these measures is not whether elected Democrats or Republicans are in the right concerning any particular policy decision, but whether regulatory agencies should be able to operate free of the political control of whichever party is in power.

The Visions and Estimates document provides an example of this in a section that examines the funding of the CFPB. Assuming that current CFPB Director Richard Cordray serves out his term, Mr. Cordray will remain in power until some point in 2018; he will keep his position for a substantial part of President Trump’s four-year term. President Trump then will be able to appoint a new CFPB director who could undo much of the previous director’s work and will serve well into the term of the next elected President, who easily could be a Democrat. In short, we could have a situation in which the unelected head of the CFPB is not financially accountable to Congress and acts in opposition to whoever happens to be President at a given time, whether Republican or Democrat. This is no way to structure a regulatory agency. Both Democrats and Republicans ought to prefer the CFPB to be funded by Congress and held accountable by elected political officials.

House Votes to Nullify SEC Resource Extraction Rule

By a vote of 235 to 197, the House of Representatives passed a joint resolution (H.J. Res. 41) to nullify an SEC final rule regarding the disclosure of payments by resource extraction issuers, Exchange Act Rule 13q-1 (the “Resource Extraction Rule”). The Resource Extraction Rule was mandated under Section 13(q) of the Securities Exchange Act, which was added by Section 1504 of the Dodd-Frank Act. The rule requires issuers to disclose certain payments made to government entities for the commercial development of oil, natural gas or minerals.

Lofchie Comment: For a long time, the Resource Extraction Rule had been criticized by Republicans as inadequate to achieve its intended purpose and irrelevant to the mission of the SEC. Seee.g.SEC Commissioner Gallagher Speaks on the Priorities and Mispriorities of the SEC (with Lofchie Comment).

GAO Issues Report on Agency Coordination and Financial Market Impact of Latest Dodd-Frank Rules

The Government Accountability Office (“GAO”) issued a report on efforts by regulatory agencies to analyze and coordinate Dodd-Frank Act rules that became effective between July 2015 and July 2016. The GAO also examined the impact of select Dodd-Frank Act rules on financial market stability.

The GAO concluded that the CFTC and prudential regulators “coordinated domestically and internationally” and “largely harmonized their respective rules” to develop regulations on margin requirements for over-the-counter swaps. The GAO found that the CFPB “followed its internal guidance for coordinating with relevant agencies throughout the rulemaking process” in adopting the integrated mortgage disclosure rule.

The GAO determined that regulators issued final rules for approximately 75% of the 236 provisions of the Dodd-Frank Act that the GAO is monitoring. GAO noted that delayed implementation of Dodd-Frank Act requirements by the financial services industry, as well as factors outside of its provisions like monetary policy, can make it difficult to isolate the effect of the Dodd-Frank Act on the financial marketplace. That said, the GAO found that, among other actions, Dodd-Frank Act implementation has had the following effects on the financial services industry:

  • large bank systemically important financial institutions have increased in size but have become less vulnerable to financial distress;
  • designated nonbanks are more resilient and less interconnected than in prior years; and
  • increased percentages of collateral for swaps by banks may help protect against credit loss.

However, the GAO stated that:

“The full impact of the Dodd-Frank Act remains uncertain because some of its rules have not been finalized and insufficient time has passed to evaluate others.”

The GAO will continue to monitor the implementation of “prior recommendations intended to improve, among other things, financial regulators’ cost-benefit analysis, interagency coordination, and impact analysis associated with Dodd-Frank regulations.”

Lofchie Comment:  There is not much in this report to get excited about. That the regulators are cooperating with respect to rulemaking is generally a good thing, but it does not necessarily say anything about the quality of the rules being adopted. The numbers demonstrating that banks have become more “resilient” are so high-level that they are of no particular value.

Trump Nominee for Treasury Secretary Wants to “Strip Back” Dodd-Frank and Cut Corporate Taxes

President-Elect Trump’s nominee for Treasury Secretary, Steven Mnuchin, stated that the “number-one problem with Dodd-Frank is it’s way too complicated and cuts back lending.” He stated that he intends to “strip back parts of Dodd-Frank that prevent banks from lending,” which will be the “number-one priority on the regulatory side.” In an exclusive CNBC “Squawk Box” interview, he described the Volcker Rule as “too complicated,” and complained that “people don’t know how to interpret it.”

In the interview, Mr. Mnuchin and Trump-appointed Commerce Secretary Wilbur Ross emphasized that tax reform is also a “number one priority.” Mr. Mnuchin stated that he would effect the “largest tax change since Reagan,” and would cut corporate taxes in order to create “huge economic growth.” Mr. Mnuchin added that this change was designed to be a “middle-income tax cut and the childcare credit is a big aspect of this.”

Lofchie Comment: Maintaining a sensible financial regulatory system, in which businesses can operate freely without fearing regulatory attacks, becomes impossible when the rules are too complex to interpret. It is refreshing to hear the simple statement from the new nominee for Treasury Secretary that some of the rules we have now are just “too complicated”!

Minneapolis Fed Requests Comments on Plan to End “Too Big to Fail”

The Federal Reserve Bank of Minneapolis (“Minneapolis Fed”) requested comments on its proposed “Minneapolis Plan to End Too Big to Fail” (the “Plan”).

In the Plan, the Minneapolis Fed proposed:

  • requiring covered banks to issue common equity equal to 23.5 percent of risk-weighted assets, with a corresponding leverage ratio of 15 percent, in order to “dramatically increase common equity capital” and “substantially reduce the chance of bailouts”;
  • calling on the U.S. Treasury Secretary to either certify that covered banks are no longer systemically important or subject those banks to an additional 5 percent of risk-weighted assets per year until (i) the Treasury certifies them as no longer systemically important, or (ii) the banks’ capital reaches 38 percent, which the Minneapolis Fed reports is the “level of capital that reduces the 100-year chance of a crisis below 10 percent”;
  • levying a shadow bank tax in order to discourage banking activity from moving to the shadow banking sector, which would equalize funding costs between the two sectors; and
  • allowing the government to reform the current supervision and regulation of community banks by adopting a system that is “simpler and less burdensome while maintaining [the government’s] ability to identify and address bank risk-taking that threatens solvency.”

Because the Plan’s approach could result in “the migration of risky activity from the banking sector to nonbank financial firms, where capital requirements are lower, if they exist at all,” it explained, the Minneapolis Fed proposed to “address this unequal treatment across sectors by taxing the borrowings of large nonbank financial firms – also known as shadow banks.” Effectively, this tax would “make the cost of funds roughly equivalent between large banks and nonbanks.”

The Minneapolis Fed requested feedback on all aspects of the Plan by January 17, 2017.

Lofchie Comment: The Minneapolis Fed’s Plan would attempt to end the problem of too-big-to-fail by driving every large bank out of business through the imposition of massive capital charges. Since putting large banks out of business would cause borrowing activity to move from banks to non-banks, the plan would then impose a tax on large non-bank lenders that effectively would force every large non-bank lender to either become a bank (presumably a small bank, since large banks would be compelled to close) or cease operations.

Since the likely effect of the Plan on the economy of the United States would be significant, the Minnesota Fed might find it useful to project what it believes the Plan’s effects would be and why. It also might be useful for the Minnesota Fed to ask itself (i) if there would be any large banks left, (ii) if there would be any large non-bank lenders left, (iii) how many banks would remain overall, (iv) what effect the Plan would have on the U.S. economy, and (v) whether it is troubling that the Plan effectively would force all large moneylenders to become banks.

Streetwise Professor Claims “Brexit Horror Story” Highlights Dangers of Clearing Mandates

In his latest post on the Streetwise Professor blog, University of Houston Finance Professor Craig Pirrong described the “horror story” of systemic clearing mandates, and explained why he remains skeptical that regulators will “take heed of the lessons of Brexit and take measures to ensure that the next time it isn’t a head shot.”

Professor Pirrong argued that “clearing mandates have supersized the clearing system, and commensurately increased the amount of liquidity needed to meet margin calls.” He highlighted Brexit as a “harrowing example” of “how tightly coupled the system is,” and listed other risk factors that clearing corporations’ response to Brexit have demonstrated. Those risk factors include the following:

  • “[m]uch of the additional margin was to top up initial margin, meaning that the cash was sucked into the [central clearing parties] and kept there, rather than paid out to the net gainers, where it could have been recirculated”; and
  • “each [central clearing party] acted independently and called margin to protect its own interests” – which is “ironic, because one of the alleged justifications for clearing mandates was the externalities present in the [over-the-counter] derivatives markets.”

Professor Pirrong observed that Brexit might prove to be as instructive as it is “horrific”:

Horror stories are sometimes harmless ways to communicate real risks. Perhaps the Brexit event will be educational.

Nevertheless, he concluded, the “clearing mandate is a reality, and is almost certain to remain one.” Given that reality, he maintained, it is doubtful that “whatever is done will make the system able to survive The Big One.”

Lofchie Comment: With respect to central clearing, the systemic risk on which regulators have focused is that clearinghouses will fail. However, the greatest risk created by central clearing as mandated by Dodd-Frank is this: in an attempt to save themselves from the risk of failure, clearinghouses could use their ability to demand an unlimited amount of initial margin from clearing member participants and so drain needed liquidity from the financial system. In other words, clearinghouses likely would save themselves from going under by sucking all of the liquidity out of the financial system. This, in turn, could trigger the failure of clearing members, or their customers who are required to post additional margin. It also could cause a downward spiral of pricing, forcing market participants to liquidate positions in order to eliminate margin calls.

Senator Urges President to Replace SEC Chair

Senator Elizabeth Warren (D-MA) “strongly urge[d]” President Obama to “immediately designate another SEC Commissioner as Chair of the agency.”

In her letter to the President, Senator Warren explained that “Chair White’s refusal to move forward on a political spending disclosure rule serves the narrow interests of powerful executives who would prefer to hide their expenditures of company money to advance their own personal ideologies.” Senator Warren highlighted Chair Mary Jo White’s “Disclosure Effectiveness Initiative” as part of her “anti-disclosure agenda” and charged that the SEC never has produced data to support Chair White’s presumption that investors experience “information overload.” She further noted that Chair White “has also refused to say how much time and agency resources have been spent on this voluntary initiative,” which Senator Warren had previously requested in a letter to Chair White. Senator Warren continued:

Giant public companies have every right to advocate for less transparency in public markets, whatever the broader economic consequences. But the SEC was not created to work for them. Under a new Chair, the agency can re-direct its limited discretionary resources away from actively undermining the interests of investors and back toward its core purposes.

Senator Warren also pointed out that, “[a]s of October 2016, the SEC has yet to finalize nineteen mandatory rules under the Dodd-Frank Act.”

Lofchie Comment: Senator Warren appears to take the view that financial regulation is but the continuation of politics by other means (paraphrasing Prussian strategist von Clausewitz). The attack on the SEC Chair is not the first shot fired by the Senator. She has launched a number of attacks on regulators and academics who have not aligned their views with hers. Seee.g.Senator Warren Asks CFTC to Withdraw EEMAC Report on Position LimitsSenator Warren Questions “Good Intentions” behind Study Challenging DOL’s Fiduciary Proposal.

The Senator’s latest missive follows closely upon the D.C. Circuit Court decision that the CFPB structure, which is commonly viewed as the Senator’s creation, is unconstitutional because the Director of the CFPB was immune from dismissal by the President. Yet now, the Senator calls for the SEC Chair to be fired because she has failed to follow “Congressional mandates.” To be consistent, the Senator should acknowledge that the CFPB’s original structure was inherently flawed in that it inappropriately insulated the agency from both Presidential and Congressional control. The President could remove the CFPB Director only “for cause.” Senator Warren seems to be arguing that SEC Chair White’s actions don’t amount to appropriate “cause” for removal, but are sufficient to designate an alternative Commissioner as Chair. Under the CFPB’s structure, that would not be possible, given that there is only one Director.

Senator Warren and her Congressional colleagues should revisit the CFPB’s design in toto, ideally replacing the single-director model with a five-person bipartisan model (i.e., similar to that of the SEC), and provide for Congressional control over the CPFB’s budget. Sauce for the goose (the SEC, the CFTC, and a host of other federal agencies) should be sauce for the gander (the CFPB).

As far as the Senator’s actual request, there is no possibility of it being granted. (Unsurprisingly, the White House indicated support for the SEC Chair.) If the President were to take the action that the Senator calls for, Chair White would resign, which would leave the SEC with only two Commissioners and, thus, the Democrats would lose their majority.

CFTC Commissioner Giancarlo Urges Regulators to Analyze Post-Dodd-Frank “Flash Crashes”

CFTC Commissioner J. Christopher Giancarlo called for a “thorough and unbiased analysis by U.S. financial regulators and their overseas counterparts of the systemic risk of unprecedented capital constraining regulations on global financial and risk-transfer markets.” Commissioner Giancarlo observed that there have been “at least twelve major flash crashes since the passage of the Dodd-Frank Act” including last week’s “abrupt ‘flash crash'” of the British pound. He asserted that:

[Regulators] can no longer continue to avoid the question of whether the amount of capital that bank regulators have caused financial institutions to take out of trading markets is at all calibrated to the amount of capital needed to be kept in global markets to support the health and durability of the global financial system [emphasis in original].

In reference to a Cabinet comment by Steve Lofchie on May 27, 2015, Commissioner Giancarlo asked the following question: “How big will the next flash crash have to be before we realize that markets in which few are able to take risks are markets that are very risky?”

Lofchie Comment: In addition to Commissioner Giancarlo’s concerns about market liquidity, his request for an “unbiased analysis” of the the systemic risk of “unprecedented capital constraining regulations on global financial and risk-transfer markets” is noteworthy. Regulators seem either reluctant or incapable of assessing whether their rulemakings have been successful, or whether certain benefits of the rulemakings might be outweighed by unintended consequences. On that topic, see this recent story about central clearing, in which we ask whether regulators are capable of judging their own work.