Monthly Archives: September 2013

Chairman Gary Gensler Testifies (with Delta Strategy Group Summary)

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CFTC Chairman Gary Gensler testified at the House Committee on Oversight and Government Reform hearing, “Preventing Violations of Federal Transparency Laws,” focusing primarily on regulators’ use of personal e-mail while working in an official capacity. In his testimony, Chairman Gensler reaffirmed the CFTC’s commitment to reforming the swaps market and bringing greater transparency to the Commission. The Chairman asserted that the CFTC has displayed a commitment to transparency by noting that the agency:

  • Posted over 2,000 meetings on the CFTC website;
  • Increased public CFTC meetings, where rules are openly debated; and
  • Initiated public roundtables to facilitate public interaction on matters before the CFTC.

Lofchie Comment: There are various ways to measure “transparency.” As we noted in yesterday’s news, one of the fellow CFTC Commissioners had complained that his questions were not included in the CFTC’s concept release on automated trading. See CFTC Concept Release on Supervision and Regulation of Automated Trading (with Delta Strategy Group Summary).

If the questions that are asked are edited, that limits the range of public debate. Separately, we had observed that the CFTC’s adoption of its cross-border regulation through “guidance,” rather than rulemaking, prevented a formal public comment process on that proposal. Industry Groups Submit Critical Comments on CFTC Cross-Border Guidance.

Click here for Delta Strategy Group Summary of Chairman Gensler’s Testimony.
See also: Full Text of Chairman Gensler’s Testimony.

 

FDIC Approves Final Rule Regarding Deposits at Foreign Branches of US Banks

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The Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) approved a final rule clarifying that deposits in foreign branches of U.S. banks are not FDIC-insured, even though they may be deposits for purposes of the national depositor preferences statute enacted in 1993. According to the FDIC, the purpose of the final rule is to protect the Deposit Insurance Fund against the liability that it would otherwise face as a potential global deposit insurer.

Lofchie Comment: Depositors should be mindful of the preference and insurance rules that govern the branch at which the deposit is “booked” (or “made”), whether it is a U.S. bank or a bank organized in another jurisdiction. It is not uncommon that different rules and a different set of preferences apply to the branches of various banks, and that branches outside of the home jurisdiction may be treated differently than branches within the home jurisdiction.

See: FDIC Press Release; FDIC Final Rule.

 

CFTC Concept Release on Supervision and Regulation of Automated Trading (with Delta Strategy Group Summary)

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The CFTC issued a Concept Release on Risk Controls and System Safeguards for Automated Trading Environments to provide an overview of the automated trading environment, including its principal actors, potential risks, and responsive measures taken by the CFTC or industry participants.  The Concept Release also discusses a series of (i) pre-trade risk controls; (ii) post-trade reports and other measures; (iii) system safeguards related to the design, testing, and supervision of automated trading systems; and (iv) additional protections designed to promote safe and orderly markets.

Lofchie Comment:  This Concept Release begins with the statement that the “U.S. derivatives markets have experienced a fundamental transition from human-centered trading venues to highly automated and interconnected trading environments.”  This much is positive in that it seems at least to promise that the regulators will engage with today’s existing markets rather than engaging in an exercise of recalling how well the markets supposedly functioned some decades ago.  That said, one is often left with the feeling that the regulators view market participants as enemies of the market, with Commissioner Chilton in his remarks taking the opportunity to repeat his urging that Congress multiply the CFTC’s sanctioning authority by about 70 times (from $140,000 a day to $10,000,000). 

It is also notable that Commissioner O’Malia concurred in the issuance of the release, but indicated that the questions he had wished to be included in the release were not.  It is unfortunate that his questions were not included in the release, particularly given that he has played a very active role in technology issues. 

Click here for Delta Strategy Group’s Summary on the CFTC Concept Release.

See: CFTC Concept Release.
See also: Chairmen Gary Gensler’s Statement of Support Regarding Concept Release; Commissioner Chilton’s Statement of Concurrence; Commissioner O’Malia’s Statement of Concurrence.

CFTC Announces Beginning of the Third Phase of Mandatory Clearing of Certain CDS and Interest Rate Swaps

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The CFTC Division of Clearing and Risk announced that the third phase of required clearing for certain credit default swaps (“CDS”) and interest rate swaps begins today, September 9.  The CFTC adopted its first clearing requirement determination for four classes of interest rate swaps and two classes of CDS on November 29, 2012.  The specifications for the CDS and interest rate swaps required to be cleared are set forth in CFTC Rule 50.4 (“Classes of Swaps to Be Cleared”).  Market participants are required to clear swaps subject to a clearing requirement determination unless an exception, exemption or other relief from required clearing applies.    

See: CFTC Press Release.
See also: CFTC Announces That Mandatory Clearing for Category 2 Entities Begins Today (June 10, 2013);  CFTC Announces the Beginning of Mandatory Clearing for Certain Swap Classes (March 12, 2013); CFTC Issues Clearing Determination for Certain Credit Default Swaps and Interest Rate Swaps (November 29, 2012); CFTC Issues Two Temporary Exemptions from the Clearing Requirement for Swaps: (i) Affiliated Counterparties and (ii) Cooperatives (November 29, 2012).

Delta Strategy Group Update: Basel and IOSCO Final Framework for Minimum Margin Requirements

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The Delta Strategy Group released an update regarding the Basel Committee on Banking Supervision’s and the International Organization of Securities Commissions’ (“IOSCO“) final framework for margin requirements for non-centrally cleared derivatives released on September 2.  Under these global standards, all financial firms and systemically important non-financial entities that engage in non-centrally cleared derivatives will have to exchange initial and variation margins commensurate with the counterparty risks arising from such transactions.

See: Click here to see the Basel Committee and IOSCO Update from Delta Strategy Group.
See also: Basel Committee and IOSCO Release Margin Requirements for Non-Centrally Cleared Derivatives Final Framework (September 4, 2013).

NFA Says, When You Mess with the CFTC, You Mess with Me; Proposes Adoption of Compliance Rule 2-49

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The National Futures Association proposed a new NFA Compliance Rule 2-49 (“Swap Dealers and Major Swap Participants Regulations”) regarding the conduct of swaps dealers and major swap participants. If approved, the amendment would specially provide that any violation by an SD or MSP of CFTC Rule 3.3 (“Chief Compliance Officer Requirements”) would be deemed a violation of an NFA requirement.

Lofchie Comment: The explanation of the proposed amendment indicates that the CFTC expected the NFA to adopt compliance rules applicable to swap dealers and major swap participants that “were at least as stringent as the Commission’s [rules].” The clear implication of the NFA’s statement is that it intended to do so.

This raises at least three interesting questions. First, what does it say about the nature of “self”-regulation if the government instructs a “self”-regulatory organization to adopt even tougher rules than the government? Doesn’t that make the SRO a mere branch of the government? Second, if the SRO is just a branch of the government, shouldn’t the same rules (cost/benefit requirements) apply to NFA rulemaking? Lastly, given that the CFTC’s own rules are just coming into force, many of them are unclear as to their requirements, and many of them have impossible deadlines that required delays, why is it necessary for the CFTC to mandate that the NFA adopt even tougher rules? How could the CFTC have sufficient evidence to know that the current rules are not tough enough?

See: Text of Proposed Amendment.
See also: YouTube Video.

Basel Committee and IOSCO Release Margin Requirements for Non-Centrally Cleared Derivatives Final Framework

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The Basel Committee on Banking Supervision and the International Organization of Securities Commissions (“IOSCO”) released the final framework for margin requirements for non-centrally cleared derivatives. Under these global standards, all financial firms and systemically important non-financial entities that engage in non-centrally cleared derivatives will have to exchange initial and variation margin commensurate with the counterparty risks arising from such transactions.

Below are key principles set out in the framework.

  1. Appropriate margining practices should be in place with respect to all derivatives transactions that are not cleared by CCPs.
  2. All financial firms and systemically important non-financial entities (“covered entities”) that engage in non-centrally cleared derivatives must exchange initial and variation margin as appropriate to the counterparty risks posed by such transactions.
  3. The methodologies for calculating initial and variation margin that serve as the baseline for margin collected from a counterparty should (i) be consistent across entities covered by the requirements and reflect the potential future exposure (initial margin) and current exposure (variation margin) associated with the portfolio of non-centrally cleared derivatives in question and (ii) ensure that all counterparty risk exposures are fully covered with a high degree of confidence.
  4. To ensure that assets collected as collateral for initial and variation margin purposes can be liquidated in a reasonable amount of time to generate proceeds that could sufficiently protect collecting entities covered by the requirements from losses on non-centrally cleared derivatives in the event of a counterparty default, these assets should be highly liquid and should, after accounting for an appropriate haircut, be able to hold their value in a time of financial stress.
  5. Initial margin should be exchanged by both parties without netting of amounts collected by each party (i.e., on a gross basis) and held in such a way as to ensure that (i) the margin collected is immediately available to the collecting party in the event of the counterparty’s default; and (ii) the collected margin must be subject to arrangements that fully protect the posting party to the extent possible under applicable law in the event that the collecting party enters bankruptcy.
  6. Transactions between a firm and its affiliates should be subject to appropriate regulation in a manner consistent with each jurisdiction’s legal and regulatory framework.
  7. Regulatory regimes should interact so as to result in sufficiently consistent and non-duplicative regulatory margin requirements for non-centrally cleared derivatives across jurisdictions.
  8. Margin requirements should be phased in over an appropriate period of time to ensure that the transition costs associated with the new framework can be appropriately managed. Regulators should undertake a coordinated review of the margin standards once the requirements are in place and functioning to assess the overall efficacy of the standards and to ensure harmonization across national jurisdictions as well as across related regulatory initiatives.

Compared with the near-final framework proposed earlier this year, the final framework includes the following modifications:

  • Exempts physically settled foreign exchange (“FX”) forwards and swaps from initial margin requirements;

  • Exempts the fixed, physically settled FX transactions that are associated with the exchange of principal of cross-currency swaps from initial margin requirements; and

  • Permits limited rehypothecation of initial margin collateral, subject to a number of conditions. 

See: Margin Requirements for Non-Centrally Cleared Derivatives Framework; Press Release.
See also: Basel Committee and IOSCO Issue Near-Final Proposal on Margin Requirements for Non-Centrally Cleared Derivatives (February 20, 2013).

Agencies Provide Model Template for Submission of Tailored Resolution Plans

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The Board of Governors of the Federal Reserve System (“Federal Reserve”) and the Federal Deposit Insurance Corporation (“FDIC”) released a model template for tailored resolution plans. Dodd-Frank requires that bank-holding companies with total consolidated assets of $50 billion or more and nonbank financial companies designated for enhanced prudential supervision by the Federal Stability Oversight Council submit resolution plans to the Federal Reserve and the FDIC. Firms are not required to use the model form.

See: Model Template; Federal Reserve and FDIC Press Release.

Regulators Issue Report to the G20 on Cross-Border Derivatives Regulation

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OTC derivatives regulators in Australia, Brazil, the European Union, Hong Kong, Japan, Ontario, Quebec, Singapore, Switzerland and the United States issued a report regarding common understandings to improve the cross-border implementation of OTC derivatives reforms.  The report reflects a number of substantive understandings to improve the cross-border implementation of OTC derivatives reforms, including the following:

  • Early and comprehensive consultation among relevant authorities when equivalence or substituted compliance assessments are being undertaken is essential.
  • A flexible, outcome-based approach should form the basis of final assessments regarding equivalence or substituted compliance assessments.
  • A “stricter-rule” approach would apply to address gaps in mandatory trading or clearing obligations.
  • Authorities have a framework for consultation on mandatory clearing determinations.
  • Jurisdictions should remove barriers (1) to reporting to trade repositories by market participants and (2) to access to trade repository data by authorities.
  • There should be appropriate transitional measures, and a reasonable but limited transition period, for foreign entities to implement OTC derivatives reforms.

Lofchie Comment:  There is nothing in the way of actual detail in the report as to how derivatives regulation will be implemented.  One might read the requirement that the various jurisdictions adopt “consistent” rules as being inconsistent with U.S. developments to date, but, obviously, that did not prevent the U.S. from agreeing with the document.  Perhaps this will signal a shift to a U.S. policy of trying to achieve greater global regulatory consistency, or it might be just a statement of goodwill that is quickly forgotten. 

The document’s emphasis on the significance of mandatory clearing is disappointing. The mandatory clearing of plain-vanilla interest rate and currency transactions will not make the economy materially safer. The failure to clear rate and currency transactions had nothing to do with the financial crisis.

See: CFTC Notice.