FINRA published this comment request on a revised proposal addressing debt research conflicts of interest, which includes some fairly substantial amendments to FINRA’s previously proposed rule as to research on debt securities as originally set forth in  FINRA Reg. Notice 11-11.  Among the changes that the new rule proposal make from the original rule proposals are:

• an exemption from the rule would be provided for research distributed to a very limited tier of institutional investors
• an exemption would be provided as to firms that engaged in limited principal debt trading activity
• the definition of “debt research report” has been amended
• the requirement of disclosure as to conflicts of interest has been limited to those that are known by, or should have been known by, the firm or analyst.

Comments Due: December 10, 2012.

Lofchie Comment:  This is a very important rule proposal that firms should produce research should review and comment upon.  In considering how they might comply with the rule, firms should not view the rule in isolation:  they must also consider the existing equity research rules and the CFTC’s rules as to research on swaps.  The “interaction” between the CFTC rules and the FINRA rules is likely to prove problematic, or to require limiting the topics discussed in research reports; e.g., firms may wish to adopt policies that limit any discussion of swaps in research reports on debt securities. 

View regulatory notice here (links externally to FINRA website).
See also: Text of the proposed rule.

The Joint Forum – which comprises the Basel Committee on Banking Supervision, the International Organization of Securities Commissions and the International Association of Insurance Supervisors – issued a final report on Principles for the Supervision of Financial Conglomerates.  The updated Principles for the Supervision of Financial Conglomerates supersede the Compendium of documents produced by the Joint Forum in 2001. The Joint Forum’s aim was to “focus on closing regulatory gaps, eliminating supervisory “blind spots” and ensuring effective supervision of risks arising from unregulated financial activities and entities.”

The principles are organized into the following five sections:

1. Supervisory powers and authority
2. Supervisory responsibility
3. Corporate governance
4. Capital adequacy and liquidity
5. Risk management

Lofchie Comment:  If you read the section of the report (beginning on page 9) on the legal framework of supervisors (that is, how the regulators should be organized and co-ordinated), and think about that Platonic structure as against the way that the US regulatory structure is designed, you are likely to reach the conclusion that the Joint Forum did not use our regulatory structure as a model for the ideal (I don’t think we would even rise to the level of a shadow of the ideal).

View report here (links externally to IOSCO website).
See also: Joint Forum Press Release.

SEC Commissioner Elisse B. Walter, the SEC’s representative on the Financial Stability Board (an international forum of prudential financial regulators), made a speech regarding international coordination (i.e., the process of regulators across jurisdictions working together to develop compatible regimes for the international financial marketplace regulation).  Commissioner Walter expressed her concern that national regulation (while appropriate because different countries are at different levels of development in their financial systems and capital markets), if left unaddressed, may unintentionally leave regulatory gaps.  On the other hand, she also noted the problem of “duplicative or even inconsistent rules” where two countries regulate the same activity by the same entity.

As to international implementation of Dodd-Frank, Commissioner Walter said that the SEC intends to address this issue in a single proposal giving investors, market participants and non-U.S. regulators an opportunity to consider as a whole the SEC’s approach to cross-border regulation of security-based swaps.  She noted that the CFTC had already published for comment a release on cross-border regulation, which she described as having generated “some angst” around the world, but stated that she was not “prepared to opine as to the content.” 

Lofchie Comment:  I think Commissioner Walter may have politely understated the “angst” generated by the CFTC’s approach to the international regulation of swaps.  (The attached news article summarizes and links to a number of the comments made by non-U.S. regulators.  One of the most notable, in my view, is that of the European Commission, which essentially threatens a trade war (see, in particular, the first sentence on page 5 of the EU letter). 
        The fact that SEC Commissioner Walter was not yet in a position to express any view, or perhaps did not feel able to express support, of the CFTC’s approach to cross-border regulation is further indication of how flawed the very structure of the U.S. financial regulatory system is.  It is hard for me to believe that the United States can function in the future as a center of global commerce with a national system of financial regulation that applies completely different cross-border rules (and rules generally) to a swap on 9 stocks than we apply to a swap on 10 stocks.  While I personally believe that there is a strong case for separate regulation by the SEC and the CFTC within separate spheres of expertise, the threat to the U.S. economy of regulators with fundamentally overlapping responsibilities who appear to act without coordination certainly argues to the contrary. 
        On a different note, I also thought there was a material contrast, at least in tone, between Commissioner Walter’s speech and the speech reported in a recent news article by CFTC Commissioner Chilton, in which he urged that non-U.S. regulators “press the accelerator” so as to catch up to the United States.  In short, the SEC approach outlined in Commissioner Walter’s speech seems to be that of seeking comment from non-US regulators, while the CFTC approach is to hold up the US as the model that non-US regulators should imitate.  (The news story on IOSCO’s regulation of money market funds in today’s updates provides yet another perspective on the differing views of US and non-US regulators.)

View speech in full here (links externally to SEC website).

IOSCO released the final report Policy Recommendations for Money Market Funds in which proposes recommendations – for the regulation of Money Market Funds (“MMFs”) throughout the world.  The report contained 15 major recommendations (at page 19) the most important of which are summarized below:

• Limits on the assets in which they invest and the risks they take
• Limits on use of repo
• Must use fair value accounting
• Must disclose to investors the possibility of principal loss
• Additional requirements should apply to funds that have a “stable” market value; e.g. funds that price at a buck
• Funds should strengthen their internal credit risk practices and not rely so much on external ratings
• Funds should conduct stress testing with the goal of surviving extraordinary market conditions.

The fundamental reason for concern over the regulation of money market funds is that such funds may contribute to systemic risk.  In this regard, the Report (at page 4) includes some a few fairly remarkable numbers as to the percentage of short-term dollar denominated CP and negotiable Certificates of Deposit that are held by money market funds.

Lofchie Comment:  The IOSCO press release (at page 1) states that the report was unanimously approved by the IOSCO Board with the exemption of the SEC Commissioners, a majority of whom did not support the report.  This is not completely surprising in light of the fact that I view the report as being implicitly (or perhaps even explicitly) critical of US regulation of money market funds (see the discussion on pages 7-8 of the report, which begins its discussion of additional “concerns” with “breaking the buck”).  In addition, I note that this past summer, the SEC Commissioners engaged in a spirited public debate as to the next steps in the regulation of money market funds in the United States with SEC Chairman Schapiro arguing that the SEC should put out new rule proposals promptly and a majority of the Commissioners asserting that further study of the issue was needed.  The links to the relevant news stories as to the positions of the various SEC Commissioners are below:

SEC Chairman Mary Schapiro’s Statement on Money Market Fund Reform 
Commissioner Luis A. Aguilar’s Statement Regarding Money Market Funds  
SEC Commissioners Gallagher and Paredes’ Statement on the Regulation of Money Market Funds

View report here (links externally to IOSCO website).
See also: IOSCO Press Release.

The CFTC has issued the attached interpretative guidance letter to asset-backed securities funds.  The guidance states that securitization funds which meet certain criteria are not included within the definition of “commodity pool” and their operators are not “commodity pool operators” under the Commodity Exchange Act and the CFTC’s regulations.

The relevant criteria include:

• The issuer of the asset-backed securities is operated consistently time  with the conditions set forth in Regulation AB, or Rule 3a-7, whether or not the issuer’s security offerings are in fact regulated pursuant to either regulation, such that the issuer, pool assets, and issued securities satisfy the requirements of either regulation;

• The entity’s activities are limited to passively owning or holding a pool of receivables or other financial assets, which may be either fixed or revolving, that by their terms convert to cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to security holders;

• The entity’s use of derivatives is limited to the uses of derivatives permitted under the terms of Regulation AB, which include credit enhancement and the use of derivatives such as interest rate and currency swap agreements to alter the payment characteristics of the cash flows from the issuing entity;

• The issuer makes payments to securities holders only from cash flow generated by its pool assets and other permitted rights and assets, and not from or otherwise based upon changes in the value of the entity’s assets; and

• The issuer is not permitted to acquire additional assets or dispose of assets for the primary purpose of realizing gain or minimizing loss due to changes in market value of the vehicle’s assets.

See: CFTC Letter 12-14 (links externally to PDF).

SIFMA submitted the attached comments to the SEC regarding a proposed Nasdaq rule change to establish “benchmark orders” under NASDAQ Rule 4751(f).  SIFMA urged the SEC to disapprove NASDAQ’s proposed rule change.

Lofchie Comment:  This is actually a pretty interesting letter, as it argues that the order type proposed to be provided by Nasdaq is inherently a “broker-dealer” function rather than an “exchange” function.  SIFMA argues, among other things, that if exchanges are performing broker-dealer functions, they ought not to benefit from limitations on their liability to others in the event of a problem.  This was an issue of regulatory attention in connection with Nasdaq’s problems with the launch of Facebook, where dealers were limited in the amount that they were able to recover from Nasdaq.

View letter here (links externally to SIFMA website).

The Basel Committee on Banking Supervision has published its third progress report on the implementation of Basel III.  This report will be the final report of the committee before January 1, 2013, which is the agreed start date for implementing Basel III.

The report focuses on the status of rule-making processes in individual countries as of the end of September 2012.  The Committee will continue to provide progress updates on implementation through 2013 and beyond.

According to the report, the United States ranks slightly behind the middle of the pack in implementation.

In this speech, Commissioner Chilton discusses the purposes of Dodd-Frank generally, the recent district court ruling on position limits rules, and the regulation of high-speed trading. 

Chilton notes that, in regard to the swaps regulations, the CFTC has received hundreds of requests for clarification and regulatory relief.  Significantly, he states that if the CFTC has not received some kind of request for regulatory relief or clarification, then “we assume they will be fully compliant with all pending deadlines…. Providing clarity as to current requests does not equate with some kind of ‘blanket pass’ on compliance.”  He goes on to state, however: “In the event we don’t answer people before this Friday, it would not be appropriate, reasonable, or responsible for the Commission to proceed against entities for non-compliance with a Dodd-Frank rule. I certainly cannot envision the Commission moving forward with such an action.”

An extended part of Commissioner Chilton’s speech concerns high-speed traders, whom Commissioner Chilton refers to as “cheetahs.”  Commissioner Chilton also states a number of regulatory responsibilities which he believes should be applied to such traders, including the requirement of registration with the CFTC, although he does not specify the provision of the CEA or the CFTC Rule pursuant to which they should register (perhaps as pools, although that registration requirement would not apply to wholly non-U.S. vehicles with no U.S. investors). 

Lofchie Comment:  Firms should read carefully his remarks as to the CFTC’s enforcement policy, and should consider, among other things, whether there are open questions they want to raise with the CFTC.  Link here for another speech, in which Commissioner Chilton describes his understanding of the CFTC’s view of enforcement where market participants have written a letter to the CFTC raising material questions.

View speech in full here (links externally to CFTC website).

The European Commission has published draft decisions by which, once finalized, it will recognize the legal and supervisory frameworks of the United States, Canada, and Australia as equivalent to the European Union requirements for credit rating agencies under the Credit Rating Agencies Regulation.  This step follows the endorsement of the regimes by the European Securities and Markets Association, which provided the European Commission with technical advice on the equivalence of the regimes in April of this year.

Lofchie Comment:  The topic of one country’s recognition of another country’s regulatory system is of tremendous significance in connection with the implementation of the Dodd-Frank swap rules; various of the non-U.S. regulators have severely criticized the CFTC for the very limited recognition it would give to non-U.S. regulatory schemes.

The Asset Securitization Forum (“ASF”) has published a request it has made to the CFTC as to the proposed extent of CFTC regulation of securitization vehicles as “pools” by reason of their entering into swaps.  The relief requested by the letter varies depending on the status of the vehicle; e.g., whether it is a “legacy” vehicle, the structure of the vehicle, and the purpose of the vehicle.

Lofchie Comment:  I would largely reiterate the comments that I made in yesterday’s news as to ICI’s challenge to the CFTC’s rule amendment that would provide for the regulation of SEC-registered investment companies as pools.  From a policy standpoint, it would seem an extremely low priority for the CFTC to regulate many of the vehicles discussed in the ASF letter, which are using swaps for hedging purposes.  It is likewise difficult to understand why the CFTC is seeking to expand its jurisdiction so broadly, given how much unfinished work that would seem to be of a far higher priority is on its plate. 
       I also note that certain major swap regulations are scheduled to go into effect on October 12, yet, as of October 8th, the CFTC has not issued widely expected timing relief, without which securitization vehicles will have a hard time operating.  This is to say nothing of the Treasury’s not yet defining the set of FX transactions that are “swaps” for purposes of Dodd-Frank (a topic that was also covered in yesterday’s news).  I find “just in time” an odd manner of doing financial regulation (is it just me?).

View letter in full here (links externally to ASF website).  See also this link to ASF web page providing background on the status of the ASF request.