The MSRB released a regulatory notice seeking comment on a proposal to consolidate into a newly proposed rule (which would be titled “G-47: Time of Trade Disclosure”) the existing requirements for dealers to disclose material information to customers in connection with the purchase or sale of a municipal security.  These disclosure obligations are currently set forth in various interpretations to the MSRB’s rule on fair dealing (Rule G-17). Under this guidance, dealers must disclose to their customers, at or prior to the time of trade, all material information about the transaction known by the dealer, as well as material information about the security which is reasonably accessible to the market.

Comments Due: March 12, 2013.

Lofchie Comment:  The MSRB proposal describes the new rule solely as a consolidation of existing interpretations for the purpose of making the MSRB’s requirements easier to follow.  Nonetheless, I strongly recommend that firms engaged in the municipals business consider the proposed rule very carefully. 

By way of example of a requirement that is worth review, the new rule would require a municipal securities dealer to disclose to a customer, at or before the initiation of a trade, all information which is reasonably accessible to the market through “established industry sources.”  That term is, in turn, defined to mean “EMMA,” rating agency reports, and other information relating to municipals that are in general use by municipal dealers.  In short, the term is open-ended.  This requirement would apply to both purchases and sales, and to transactions that were both solicited and unsolicited.  Further, the disclosure requirement cannot be satisfied by the dealer’s directing the customer to an established industry source. 

This requirement seems potentially ambiguous and expensive.  Further, I wonder if it is really in customers’ best interests.  That is, if a retail customer wants to sell an existing municipal securities position in order to raise cash, (i) is it going to be worthwhile for a broker-dealer to do all of the necessary research before the broker-dealer can buy the securities and (ii) is the expense of doing the research going to take a good chunk out of what is offered to the customer (presuming that, ultimately, customers must bear the cost of gathering the information required to make this disclosure)?

Leaving aside the municipals market, firms should review the proposal and consider whether it has implications for other markets and products. 

See: MSRB Notice 2013-04.

The Joint Forum released a consultative report on mortgage insurance which analyzes the interaction of mortgage insurers with mortgage originators and underwriters.  The report makes recommendations directed at policymakers and supervisors, and aims to reduce the likelihood of mortgage insurance stress and failure in the worst tail events. Thomas Schmitz-Lippert, Chairman of the Joint Forum, urged the adoption of these recommendations, stating they will help strengthen and reinforce the oversight of mortgage insurers and thereby increase their resilience over the long term.

Lofchie Comment:  Even if you don’t work in a job at all related to mortgage insurance (I don’t), this was an interesting piece for its explanation of mortgage insurance as a product, and because it provides a discussion of the use of the product outside the United States, which gives one perspective in light of the financial crisis.

In response to the Lehman Brothers and MF Global insolvencies, the International Organization of Securities Commissions (“IOSCO”) published recommendations for improving the protection of client assets.  The report suggests that financial intermediaries and regulators should take a more proactive role in ensuring the safety of client assets.  Specifically, the report makes the following suggestions:

1. To ensure compliance with the rules and regulations governing client assets, intermediaries must develop internal systems to monitor compliance;
2. Intermediaries should maintain accurate records of client assets that establish the nature, amount, location, and ownership status of each client’s assets;
3. Accounts held with a third party for the benefit of clients should be titled in such a way to clearly distinguish assets held for the client from assets held from the intermediary;
4. When client assets are held in a foreign jurisdiction, the intermediary should inform the client of this fact and disclose the material differences of the foreign jurisdiction’s insolvency regime;
5. Where the jurisdiction allows the client to waive or modify its rights under the jurisdiction’s client asset protection regime, such waiver should be signed by the client and clearly explain the effect of doing so;
6. Regulators should require periodic reports from intermediaries detailing the amount, location, and value of client assets held, in addition to a report evaluating the intermediaries’ compliance with the relevant client asset protection regimes; and
7. To improve orderliness in the event of insolvency, regulators should also take affirmative steps to promote information sharing between jurisdictions.

Lofchie Comment:  Recommendation 4 has merit but I question the procedure.  Would it not make more sense for each government to produce a description of the way that its insolvency regime worked than for each intermediary to attempt to figure out the various insolvency regimes in 100 different countries?
 
As to the other recommendations listed above, other than item 7, which is a government-to-government issue, each of them is consistent with existing U.S. law governing broker-dealers and FCMs. 

SIFMA, The Clearing House (“TCH”) and The Financial Services Roundatable (“FSR”) provided the attached comments to the CFTC on Further Proposed Guidance Regarding Compliance with Certain Swap Regulations (78 FR 909).  The letter provides detailed commentary on the CFTC’s specific proposals in the Further Proposed Guidance. The main points are as follows:

1. The groups do not support the proposed clarifications to two prongs of the proposed “U.S. person” definition.
2. The groups believe that both the concept of indirect majority ownership and the concept of “bearing unlimited responsibility” for obligations and liabilities are ambiguous, and create “significant and unachievable compliance burdens” in determining a party’s U.S. person status.
3. The groups do not support the proposed alternative interpretation of the aggregation requirement, which requires aggregation of swap transactions of non-U.S. persons with U.S. affiliates.

Lofchie Comment:  Reading the detailed criticism of the CFTC’s guidance in the SIFMA letter, in conjunction with the extensive comments sent to the CFTC by banking and fund associations, makes two things clear:  (a) neither the buy-side nor the sell-side wants much to do with these rules that are supposed to make the markets better and safer; and (b) the CFTC is far away from actually having a workable regulatory structure, not matter how many rules it may have proposed or even adopted.  Worse, three of the most basic regulatory questions remain wholly unresolved: (i) although we have a definition of “swap,” it is so overly broad and convoluted that no understands it, and I have no doubt that it will be regularly “misinterpreted” outside the geography of the United States because no one is going to be willing or able to invest tends of thousands of dollars of lawyer time to “correctly” interpret a term which is wholly dependent on “facts and circumstances”; (ii) issues of geographic and territorial  jurisdiction are hardly more advanced than they were when Dodd-Frank was adopted, with the CFTC’s having put out wildly divergent proposals with no explanation of the theory or policy that underlies any of them; and (iii) it is not clear how the regulatory status of one member of a corporate group is affected by the activities of its affiliates.

Click here to view comment letter in full (links externally to SIFMA website).
In yesterday’s news, we published and commented on two other industry trade letters that were critical of the CFTC’s proposed definition of “U.S. person”:  see IIB Final Comment Letter on CFTC Further Proposed Cross-Border Guidance; MFA and AIMA Submit Joint Letter to CFTC on Further Proposed Cross-Border Guidance.

On February 5, the SEC held a roundtable (webcast available here as Part 1 and Part 2) to evaluate the impact of tick sizes on the securities markets.  The roundtable consisted of three panels:

• The first panel addressed the impact of tick sizes on small and mid-sized companies, the economic consequences of increasing or decreasing minimum tick sizes, and whether other policy alternatives might better address concerns related to Section 106(b) of the JOBS Act.
• The second panel addressed the impact of tick sizes on the securities market in general, including what benefits may have been achieved and what, if any, negative effects have resulted.
• The third panel addressed potential methods for analysis of the issues, including whether and how to conduct a pilot for alternative minimum tick sizes.

In his opening remarks, Deputy Director of Trading and Markets, James Burns, suggested that a data-driven approach can be developed that will “prove fruitful for addressing tick sizes and that this type of data-driven approach provides a useful template for addressing many of the other complex and pressing market structure issues.”

Lofchie Comment:  I am certainly in favor of a data-driven approach.

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

The Institute of International Bankers (“IIB”) has published a comment letter in which it offers suggestions across three key topics: (i) the aggregation rule, (ii) the “U.S. person” definition, and (iii) matters relating to the transition from the Final Order. 

In the letter, the IIB states that it supports the CFTC’s adoption of a modified version of the Final Exemptive Order Regarding Compliance with Certain Swap Regulations (78 FR 858), which it believes addresses two key elements of the Title VII regulatory regime:

1. the aggregation of affiliates’ swaps for purposes of the de minimis exception from the swap dealer definition, and
2. the definition of “U.S. person.”

The IIB suggests, however, that additional modifications are necessary to respond to comments received by the CFTC on the Proposed Guidance and “facilitate good faith compliance with Dodd-Frank.”  In particular, the IIB requests that the CFTC reexamine the policy of its aggregation requirements (that is, that affiliated entities aggregate their swaps activities for purposes of determining whether swaps registration will be required), as IIB believes that many firms which do a very limited swap business may be either drawn into the dealer registration requirement or forced to stop doing business with U.S. customers.

Quite a bit of the letter discusses some of the broad definition of “U.S. person” set forth in earlier CFTC guidance, and explains why such such a broad definition would be problematic for both non-U.S. market participants and non-U.S. regulators. 

Lofchie Comment 1:  The difficulty with commenting on the CFTC’s proposed definition of “U.S. person” is that the CFTC has issued at least three quite inconsistent definitions with no explanation of the policy rationale behind them, nor any explanation of how the CFTC intends to coordinate with non-U.S. regulators under any of the definitions.   The proposal that the IIB praises has the benefit of being the narrowest and simplest of the various definitions, but the CFTC gives no indication of whether it is tending to adopt such a definition, or has simply thrown out a narrow definition as a stop gap to avoid confronting the fact that the rest of the world has no idea what the CFTC intends to assert in the way of global jurisdiction, and the CFTC is not sure what it intends either in the face of increasing global resistance to its jurisdiction.

Lofchie Comment 2:  The argument in the IIB letter which most hits home for me, but also worries me, is the statement that non-U.S. market participants simply do not want to enter into the agreements that U.S. dealers require in order to comply with Dodd-Frank.  

In short, Dodd-Frank is not drawing financial business to the United States from foreign investors who want the safety of the U.S. markets.  Its the opposite: Dodd-Frank is scaring financial business out of the United States because foreign investors do not want to deal with the complexity, burdens, cost and confusion of U.S. regulation.  This observation by the IIB is consistent with a comment I made in a recent blog post as to the results of a trip I had made to advise clients in Hong Kong.  Non-U.S. commercial and financial customers would rather forego transacting with U.S. firms than become subject to Dodd-Frank.  This result cannot be anything other than destructive for the U.S. economy and damaging to the (central?) place of the U.S. in the world economy.

It is of course possible to dismiss my concerns as to our economy given that I am a persistent critic of Dodd-Frank – at least it would be possible if these concerns were impossible to verify – but my concerns can be tested.  If the regulators are trying to make U.S. markets attractive to foreign investors, they should simply hire a private marketing firm to poll non-U.S. investors and ask whether Dodd-Frank makes them more or less likely to trade with U.S. financial institutions.  If the answer is that they are less likely, then the regulators should ask themselves why rules intended to make market participants safer are instead having the effect of driving them away.

Click here to view letter in full (links externally to IIB website).
See also: CFTC Approves Exemptive Order on Cross-Border Application of the Swaps Provisions of Dodd-Frank (Fed. Reg. Version).

The MFA and AIMA jointly submitted a comment letter to the CFTC on its Final Exemptive Order Regarding Compliance with Certain Swap Regulations (78 FR 858).  MFA and AIMA expressed continued concern with the “breadth of the definition and its application to non-U.S. funds.”  In particular, MFA and AIMA urged the CFTC to provide equal treatment of funds and corporate entities by modifying the proposed “U.S. person” definition to “eliminate the ‘look-through’ to all indirect investors, and apply only the tests in alternative prong (ii) to funds, specifically, the tests related to place of organization, majority direct ownership, and unlimited liability.”

The MFA and AIMA also asked the CFTC to clarify that:

1. A fund’s principal place of business is its place of organization or incorporation,
2. A fund may rely on representations from its investors as to the investors’ U.S. person status, and
3. If it modifies the “U.S. person” definition in the future, it will give notice, an opportunity for the public to comment, and one year for affected entities to comply with the relevant regulatory requirements.

Lofchie Comment:  Consistent with the disparaging comments that I made about Dodd-Frank in the prior blog post, here is the proof of my concern that the customers whom Dodd-Frank was supposedly intended to protect are trying to avoid being deemed U.S. persons so that they are not forced to be “protected.”  (In short, business is going to move out of the United States to avoid the burdens of Dodd-Frank.  The damage done to the U.S. economy if the United States is no longer the global financial market place will be considerable over the long run and will not be easy to reverse.)

Click here to view letter in full (links externally to MFA website).