Monthly Archives: September 2013

SIFMA Comments on SEC MMF Proposal

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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).

Embedded Financing: The Unsung Virtue of Derivatives by Bruce Tuckman

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CFS Senior Fellow Bruce Tuckman wrote a paper for The Journal of Derivatives titled “Embedded Financing: The Unsung Virtue of Derivatives.” The paper was printed in the Fall 2013, Vol. 21, No. 1: pp. 73-82 journal.

Abstract:

In theoretical derivatives pricing models, such as those for equity options, the interest rate is often simply specified as r, a fixed constant rate on a “bond” with no default risk. Rates must be treated as stochastically time varying for interest rate derivatives, but still, little attention is paid to the “financing rate.” Tuckman points out that this oversimplifies what happens in the real world. The proper financing rate to use in pricing a given derivative, and especially in setting up an arbitrage trade against the underlying, depends on the specific market practices the trader will face regarding collateral requirements, securities lending terms, and the availability of long-term financing markets (or lack of them). In theory, buying a bond in the cash market and “putting it out on repo” should yield the same payoff as a forward contract on the bond. But this requires financing the bond over the lifetime of the trade, which is rarely possible at a rate that is fixed ex ante for the whole period. The cash market transaction, financed by rolling over short-term repo loans, entails financing risk that the equivalent forward contract does not have. Embedded financing is an important, and frequently overlooked, benefit of derivatives.

To go to The Journal of Derivatives website, click here.

ABA Submits Comments to Treasury and Prudential Regulators Regarding CFTC Cross-Border Regulatory Interpretations

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The American Bankers Association (“ABA”) submitted comment letters to the U.S. Treasury and Prudential Regulators regarding the CFTC’s October 10 clearing requirement for interest rate and index credit swaps entered into between overseas branches and non-U.S. customers, and the conditions under which a swap is to be executed with an overseas branch.

The letters stated that the ABA believes that key aspects of the CFTC’s interpretations on cross-border implementation will “impose avoidable harm on U.S. businesses through measures that are not required to meet its systemic risk management goals” by restricting the ability of overseas branches of U.S. banks to participate in local swaps markets and forcing them to rely on direct competitors to meet financial services needs.  The letters stated that the ABA plans to send the CFTC a similar letter requesting the reevaluation of two aspects of their cross-border interpretations, including:

  • to consider delaying the October 10 date and provide for an appropriate phase-in period for the mandatory clearing of interest rate and index credit swaps entered between a U.S. bank’s overseas branches; and 
  • to reconsider the restrictive set of conditions on the circumstances in which a given swap can be considered to be executed with an overseas branch of a U.S. bank.

Lofchie Comment:  The reason why the Administrative Procedures Act requires that proposed rules be submitted for public comment is to allow the public, including market participants, to raise issues, including problems with rulemaking that may potentially damage the U.S. economy.  The decision that the CFTC made to adopt the Interpretative Guidance on cross-border issues without going through an ordinary rulemaking process will create problems that are not going to go away.  It would be better if the CFTC would simply put the Interpretative Guidance on hold and then propose it for public comment in the Federal Register.

See:  ABA Letter to Treasury; ABA Letter to Prudential Regulators.
See also:  SIFMA AMG Submits Comments to CFTC on Cross-Border Phase-in Exemptive Order and Final Interpretive Guidance (August 26, 2013); MFA and AIMA Submit Letter to CFTC on Cross-Border Exemptive Order Asking Delay of Reporting Requirements and on Changes to Status as U.S. Person (August 26, 2013); Industry Groups Submit Critical Comments on CFTC Cross-Border Guidance (August 14, 2013); CFTC Issues Notice of Expiration of Cross-Border Exemptive Relief (August 1, 2013); CFTC Approves Cross-Border Guidance and Exemptive Order (July 15, 2013).

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

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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 stress.  The 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).

MFA and AIMA Submit Letter to ESMA on Contracts Having Effect within the EU

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The Managed Funds Association (“MFA”) and the Alternative Investment Management Association (“AIMA”) submitted a letter to the European Securities and Markets Authority (“ESMA”) in response to a consultation paper regarding regulatory technical standards on contracts having a direct, substantial and foreseeable effect within the Union and non-evasion of provisions of European Market Infrastructure Regulation (“EMIR”).  In the letter, the MFA and the AIMA asked ESMA to clarify whether a fund that is “established” in a third country is subject to the rules of that country’s regime, and also made suggestions and recommendations.

See:  MFA Blog Press Release; MFA and AIMA Letter to ESMA.

CFTC Technology Advisory Committee Meeting (with Delta Strategy Group Summary)

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The CFTC held a Technology Advisory Committee (“TAC”) meeting chaired by CFTC Commissioner Scott O’Malia to cover subjects such as swap data reporting, the CFTC concept release on automated trading, swap execution facilities (“SEF”), and made available to trade submissions (“MAT”).  Key takeaways from the meeting include suggestions for basic market structure improvements in response to the concept release targeting algorithmic trading, as well as a  discussion of the approaching October 2 deadline for mandatory SEF registration. 

Lofchie Comment:  The attached Delta Strategy Group summary of the TAC meeting is very thorough. While the summary should be reviewed by anyone with an interest in the development of CFTC requirements, the most significant part of the summary is the panel discussion of “Credit Checks and Clearing Certainty.”  It is somewhat remarkable that just before the launch of SEFs, there is complete uncertainty as to whether, or how, trading on SEFs will proceed in the absence of clearing certainty.  It is also somewhat surprising that the CFTC staff seems to be taking a view on how a broken trade should be handled (according to staff, treating it as if it never happened seemingly without the payment of damages) as that more properly seems a matter of negotiation between the parties.

Click here for a summary of the TAC meeting authored by  Delta Strategy Group.

See: CFTC Chairman Gensler’s TAC Meeting Statement; CFTC Commissioner Chilton’s TAC Meeting Statement.
See also: CFTC Concept Release on Supervision and Regulation of Automated Trading (with Delta Strategy Group Summary) (September 10, 2013); CFTC Publishes Text of SEF Rules (May 21, 2013).

CFTC Publishes Concept Release on Risk Controls and System Safeguards for Automated Trading Environments (Fed. Reg.)

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The CFTC published a Concept Release and requested comments on risk controls and safeguards for automatic trading systems in the Federal Register. In the release, the CFTC noted that traditional risk controls and safeguards which relied on human judgements must be reevaluated, due to the transition of highly automated and interconnected trading environments.  The Commission also stated its continuing commitment to the safety and soundness of the U.S. derivatives market.  Comments must be submitted by December 11, 2013.

See: 78 FR 56542.
See also: CFTC Concept Release on Supervision and Regulation of Automated Trading (with Delta Strategy Group Summary) (September 10, 2013).

MFA and AIMA Submit Letter to ESMA on EMIR Clearing Obligation

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The Managed Funds Association (“MFA”) and the Alternative Investment Management Association (“AIMA”) submitted a joint letter to the European Securities Markets Authority (“ESMA”) in response to its paper on the clearing obligation under the European Market Infrastructure Regulation (“EMIR”).  In the letter, the MFA and AIMA said that the types of derivatives contracts which should be subject to mandatory clearing in Europe generally should be of the same type that are subject to such clearing in the United States.  The MFA and AIMA also opposed generally a phase-in of the EMIR clearing obligation that would require certain types of parties to go first (arguing that everyone should be subject to the clearing requirement at the same time).  Finally, the trade associations opposed the possible retroactive application of the clearing obligation to trades already negotiated. 

See: MFA/AIMA Letter; MFA Press Release. 
See also: ESMA Discussion Paper.

FDIC Publishes Basel III and Capital Requirement Rules (Fed. Reg.)

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The FDIC published interim final rules regarding the implementation of Basel III and other capital requirements in the Federal Register.  Comments are due November 12, 2013.  This interim final rule is substantially identical to a joint final rule issued by the Office of the Comptroller of the Currency (“OCC”) and the Board of Governors of the Federal Reserve System (“FRB”).  The interim final rule consolidates three separate notices of proposed rulemaking that the agencies had published jointly in the Federal Register on August 30, 2012, albeit with some changes.

See: 78 FR 55339.
See also: FDIC and OCC Adopt Rules Regarding the Implementation of Basel III Capital Requirements (July 10, 2013); Delta Strategy Group: Summary of New Basel Capital Proposals (July 3, 2013).