Today we release CFS monetary and financial measures for February 2014. CFS Divisia M4, which is the broadest and most important measure of money, grew by 2.0% in February 2014 on a year-over-year basis versus 0.8% in January.
For Monetary and Financial Data Release:
http://www.CenterforFinancialStability.org/amfm/Divisia_Feb14.pdf
SEC Director of the Division of Investment Management (the “Division”) Norm Champ delivered a speech, at the 2014 Mutual Funds and Investment Management Conference, about recent developments and rulemaking initiatives within the investment management industry.
According to Mr. Champ, it is important for the Division to innovate in order to keep up with the market, and such innovation begins with the internal organization of the Division. Mr. Champ stated that the Division was recently restructured into four groups to reflect its key functions: (i) disclosure, (ii) guidance by the Chief Counsel’s office, (iii) rulemaking and (iv) business operations, including risk monitoring and analysis. Mr. Champ noted that this reorganization will ensure the continued cooperation between outside stakeholders and the Division. In this regard, he described the exemptive application process as “the laboratory where we examine and consider new ideas from market participants.” Mr. Champ also mentioned the newly created Risk and Examinations Office (“REO”), which maintains an industry-monitoring program to provide ongoing financial analysis of the investment management industry, with a particular focus on strategically important investment advisers and funds.
Director Champ also discussed rulemaking initiatives, explaining that the Division uses a four-factor approach to analyzing policy initiatives: (i) a thorough review of the risk or risks to be mitigated by the proposed rulemaking, (ii) a consideration of the urgency associated with a particular initiative, (iii) an analysis of the potential impact of an initiative on investors, registrants, capital formation, markets and the SEC’s operational efficiency, and (iv) a review of the applicable resources associated with a policy initiative. Mr. Champ went on to describe rulemaking achieved in the last year, including a new rule to implement the JOBS Act requirement to lift the ban on general solicitation and general advertising for certain offerings, an area where, he indicated, more rulemaking was in progress. He also stated that the staff was studying potential money-market mutual fund reforms, as well as other reforms related to disclosure by investment companies.
As to other product areas in which the staff was considering rulemaking initiatives, Director Champ mentioned variable annuities and retirement funds.
Furthermore, Mr. Champ said, in addition to increasing the amount of staff Guidance Updates issued to better inform the public, the Division is also seeking ways to inform its own staff about industry developments and has met with senior management at funds, advisory firms and fund boards to discuss trends and issues in the industry. Regarding these issues, Mr. Champ noted that the Division will monitor the migration of individual investors from brokerage accounts to advisory accounts, as well as the challenges that funds and investment advisers face concerning cyber security risks. As to cyber risks, he said that advisers should have procedures both to protect fund information and to mitigate the impact of any cyber-attack (a “rapid response capability”).
Lofchie Comment: Two points stood out in SEC Director Champ’s remarks: (i) cyber security and (ii) the movement of accounts from brokerage accounts to advisory accounts. As to the latter, it is predictable that regulatory pressure to impose “fiduciary” obligations on brokers who give any investment advice would result in their transferring full-service customers (that is, customers who receive advice as an incident to securities brokerage) into advisory accounts.
It seems both unprofitable and imprudent for brokers to give advice to retail customers on a transaction-fee basis if the brokers may then be held liable for failure to consider their clients’ overall financial situation. The imposition of a fiduciary obligation on brokers cannot be compensated for on the basis of transaction fees. These obligations could have a negative effect on smaller clients if the obligations resulted in broker-dealers discontinuing the offer of full service to smaller retail clients.
See: Director Champ’s Remarks.
The CFTC submitted a Memorandum responding to a Complaint filed in federal district court by three financial industry trade associations – ISDA, SIFMA and the Institute of International Bankers (“IIB”) (together, the “Associations”) – challenging the legality of the CFTC’s Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (“Cross-Border Guidance” or “Guidance”). In addition to arguing that the plaintiffs lack standing and that their challenge is not ripe, the CFTC contends in its latest response that the 2010 Dodd-Frank law “unambiguously” states that the agency’s rules apply to overseas activities with a “sufficient” nexus in the United States.
In response to the contention that the Guidance is in reality a rule that was not issued in compliance with the Administrative Procedure Act, the Memorandum states that: 1) there is no requirement that the CFTC implement Dodd-Frank’s cross-border authority by rulemaking, and 2) the CFTC reasonably chose not to issue a rule, but instead issued a general statement of policy that is not reviewable under the APA. The CFTC Memorandum also states that the CFTC’s interpretation of CEA Section 2(i) (the provision in the CEA that provides for cross-border authority) is reasonable, and that it properly considered the costs and benefits and public comments associated with the Guidance.
Lofchie Comment: That the CFTC’s Guidance is actually a “rule” issued in contravention of the Administrative Procedures Act is a widely held view.
With regard to a “race to finish” rulemaking, a loss on this case will be very damaging to the CFTC, as it will be forced to reexamine many of the rules that it had raced to complete. Notwithstanding the short-term damage that would be done to the CFTC’s rulemaking by losing this case, in many ways, the CFTC could be better off with a loss. If it wins the case, it will have done so by conceding that the Guidance is not binding on anyone. This means that, in every future CFTC enforcement action that has a cross-border element, the CFTC will be forced to re-argue how its nonbinding guidance applies to that action. Among other consequences, this would be a great waste of the agency’s resources. Perhaps even more significantly though, losing the case might create an avenue that would allow the CFTC to revisit many of its recent and poorly considered rules.
See: CFTC Memorandum.
Related news: Market Participants File Lawsuit Challenging CFTC Cross-Border Guidance for Being a Rule Adopted in Violation of the APA (December 4, 2013); Market Participants File Amended Complaint Challenging CFTC Cross-Border Guidance (January 8, 2014); Chamber of Commerce Submits Amicus Brief Regarding Lawsuit against CFTC Cross-Border Rule (February 5, 2014); SIFMA and AFME Issue Statement on Transatlantic Financial Regulation Negotiations (February 19, 2014).
One More Argument over Rules vs. Guidance (on a wholly unrelated subject).
SIFMA submitted comments to the CFTC requesting time-limited no-action relief relating to confirmations for swaps not required or intended to be cleared.
SIFMA’s letter echoed a recent letter to the CFTC from the Global Foreign Exchange Division (“GFXD”) of the Global Financial Markets Association (“GFMA”), which requested that the CFTC Division of Marketing Oversight (“DMO”) not recommend enforcement action against a swap execution facility (“SEF”) that has failed, prior to January 1, 2015, to comply with the requirements of the CFTC in connection with swap transactions executed on the SEF that are not required or intended to be submitted for clearing, provided that certain conditions listed in the letter are met.
According to SIFMA, the relief requested by GFXD intends to establish a transitional confirmation and reporting protocol, and to establish a relationship between specific economic transaction terms and non-transaction specific relationship terms consistent with conventional documentation architecture used throughout the financial markets while ensuring that these arrangements support the CFTC’s public and regulatory transparency requirements and do not facilitate the circumvention of CFTC regulatory reporting requirements or SEF rules through bilaterally negotiated documentation terms.
SIFMA urged the DMO to provide the time-limited no-action relief requested in the GFXD letter.
See: SIFMA Comment Letter.
See also: GFXD Comment Letter.
FINRA released the first podcast in a five-part series that provides an overview of FINRA’s 2014 examination priorities. The podcast primarily focuses on FINRA’s business conduct priorities regarding suitability. In this podcast, FINRA stated it remains concerned about the suitability of recommendations to retail investors for complex products whose risk-return profiles (including their sensitivity to interest rate changes, underlying product or index volatility), fee structures or complexity may be challenging for investors to understand. FINRA also stated that examinations will include a review of the training given to retail-facing brokers to determine whether they understand the products they recommend so they can have proactive conversations about product-specific risks with their customers.
Specifically, FINRA intends to focus on the marketing, sales, and suitability of:
Lofchie Comment: The participants on the podcast are clearly concerned that the economy is vulnerable to a rise in interest rates that would depress the value of long-term bonds, thus hurting the stock market. In addition, there was a good deal of concern expressed about various types of issuers, particularly with regard to municipal issuers.
See: FINRA Podcast.
Related news: FINRA Releases 2014 Regulatory and Examination Priorities (January 6, 2014).
Three legislative proposals to amend the Commodity Exchange Act (“CEA”) have been introduced in the House. All three bills focus on specific parts of the CEA.
H.R. 677 – “Inter-Affiliate Swap Clarification Act” – would exempt swaps between certain affiliated entities within a corporate group and swaps between companies or subsidiaries that share some level of common ownership from the clearing and trade execution requirements of CEA Section 2(h), and applicable margin and capital requirements of CEA Section 4s(e). The bill would also clarify that, for purposes of defining “swap dealer” or “major swap participant” and certain reporting requirements, the term “swap” does not include any agreement, contract or transaction entered into by certain affiliated parties.
H.R. 3814 – “Risk Management Certainty Act” – would amend CEA Section 1a(49), which provides for an exemption from designation as a swap dealer for dealers engaged in a de minimis amount of swap dealing. The proposed bill would require that such de minimis quantity not be less than $8 billion and that any change of such level be by vote of the Commission.
H.R. 634 – “Business Risk Mitigation and Price Stabilization Act of 2013” – would amend CEA Section 4s(e) to exempt end users from the margin requirements for uncleared swaps imposed by that section of the CEA. A similar exemption would apply to affiliates that satisfy the criteria of CEA Section 2(h)(7)(D), i.e., use swaps to hedge or mitigate commercial risk.
Lofchie Comment: These all seem to be reasonable measures (albeit speaking as someone who thinks Dodd-Frank is generally a bad law).
The first of the bills would diminish the CFTC’s regulation of swaps between affiliates. While the CFTC has granted limited affiliate exemptions by rulemaking, the exemptions are subject to complicated conditions, and there are numerous situations where affiliated parties cannot benefit from the CFTC’s exemptions.
The second provision would effectively freeze the current de minimis level beyond which a swap dealer is not required to register with the SEC at $8 billion (the CFTC currently plans that it should be reduced to $3 billion). The very significant problem with reducing the registration level to $3 billion is that complying with the CFTC’s swap regulations is expensive, probably too expensive for a small swap dealer to absorb. Accordingly, small swap dealers that do between $3 billion and $8 billion in notional swaps would likely decide that it was not worthwhile to register with the CFTC and would instead reduce or eliminate their swaps dealing activities so as to avoid the costs of registration. This would increase the concentration of business in the largest swap dealers, a result that Dodd-Frank was supposedly intended to avoid. Put differently, the question is whether reducing the registration level from $8 billion results in significantly more registered swap dealers or significantly fewer overall swap dealers: my prediction would be significantly fewer swap dealers. (It should be possible for the CFTC to conduct an analysis of the costs of regulation, and to make a better-informed prediction as to the effects of reducing the notional amount that would trigger dealer registration.)
The third bill would provide a benefit to end users by exempting them from clearing, and thus from the need to post high-quality collateral in respect of their cleared swaps. Given that many end users could find more productive uses for their cash than posting it to a swaps clearing corporation, and given that it would be better for the economy if end users put their cash into investments, this also seems a reasonable measure.
See: H.R. 677; H.R. 3814; H.R. 634.
See also CFTC Letter 13-09 (providing an example of the quite complicated CFTC requirements that must be met in order for swaps between affiliates to benefit from a limited exemption from otherwise applicable requirements).
SIFMA submitted comments to the CFTC, SEC, the Board of Governors of the Federal Reserve System (“FRB”), the Office of the Comptroller of the Currency (“OCC”), FDIC, the Federal Housing Finance Agency (“FHFA”) and the Farm Credit Administration (“FCA”) (collectively, the “Agencies”) on margin requirements for non-centrally cleared swaps and security-based swaps (“SBS”).
SIFMA stated that it understands the Agencies are considering modifications to the proposed margin requirements for non-centrally cleared swaps and SBS in order to harmonize U.S. margin requirements with the final policy framework agreed by the Basel Committee on Banking Supervision (“BCBS”) and IOSCO for margin requirements for non-centrally cleared derivatives (“BCBS-IOSCO Framework”). SIFMA noted that the Agencies’ principal objective should be to ensure inter- and intra-national consistency in margin requirements for non-centrally cleared derivatives in the BCBS-IOSCO Framework.
To achieve this objective, SIFMA recommended that the Agencies take a number of steps to address key issues, including:
See: SIFMA Comment Letter.
Related news: Basel Committee and IOSCO Release Margin Requirements for Non-Centrally Cleared Derivatives Final Framework (September 4, 2013); Delta Strategy Group Update: Basel and IOSCO Final Framework for Minimum Margin Requirements (September 6, 2013).
SIFMA submitted comments to the MSRB regarding the draft best execution rule, including the exception for transactions with sophisticated municipal market professionals.
SIFMA stated that it supports an execution standard for the municipal market that is structurally similar to FINRA Rule 5310 (“Publication of Transactions and Quotations”). In the letter, SIFMA disagrees with applying equity-based execution standards to the municipal market. Instead, SIFMA argued that rules and standards involving execution should reflect their “fundamental limitations and objects to rules that implicitly or explicitly import notions of best execution more appropriately applied to markets for more liquid equity and corporate debt securities.”
Furthermore, SIFMA stated that an execution diligence process resulting in a price that is fair and reasonable under market conditions is a more appropriate balance of investor protection interests with efficient markets. SIFMA requested that the MSRB provide further guidance regarding the harmonization of Rule G-18 (“Execution of Transactions”) and Rule G-30 (“Prices and Commissions”), as well as compliance issues. SIFMA recommended that the MSRB separately issue a request for data and other information, in particular quantitative data, relating to the benefits and costs that could result from various alternative approaches regarding the standards of conduct and other obligations relating to its proposal.
Lofchie Comment: The history of the regulation of securities trading is that equity markets are regulated first, and then other markets (first debt and now swaps) are then made subject to similar regulations. SIFMA’s primary argument is that the market for debt is very different from the equities markets and thus it is not obvious that the debt rules should imitate the equity rules. This is, on its face, a reasonable position, but one that would require the MSRB and other securities regulators to take a wholly fresh look at the market, rather than treat fixed income regulation as simply a variant of equity market regulation.
See: SIFMA Comment Letter.
The SEC voted to propose new rules that would enhance the oversight of clearing agencies that are deemed to be systemically important by the Financial Stability Oversight Council (“FSOC”) or that are involved in complex transactions, such as security-based swaps (“covered clearing agencies”). The covered clearing agencies would be subject to new and “more robust” requirements regarding their financial risk management, operations, governance, and disclosures to market participants and the public. The proposal also would establish procedures for the Commission to use to apply the new requirements to additional clearing agencies.
The proposal would amend Exchange Act Rule 17Ad-22 (“Standards for Clearing Agencies”) and add Rule 17Ab-2-2, pursuant to Exchange Act Section 17A (“National System for Clearance and Settlement of Securities Transactions”) and the Payment, Clearing and Settlement Supervision Act of 2010 adopted in Dodd-Frank Title VIII. Specifically, the proposed rules would require covered clearing agencies to adopt policies and procedures to address systemic risk concerns in the areas of governance, financial risk management, stress testing, default management and operational risk management, among others. The proposal includes rules that address a covered clearing agency’s operational risks, such as deficiencies in information systems and internal controls, unauthorized intrusions into automated systems and disruptions from natural disasters.
According to SEC Commissioner Aguilar, it is “important to note that these rules are designed to work hand in hand with the Commission’s pending Regulation SCI, which will cover all clearing agencies.” Commissioner Piwowar stated that, while he is pleased that the SEC is reviewing the oversight of clearing agencies proactively, he is “not convinced that the proposal sufficiently justifies the imposition of the entire package of new requirements,” and noted that the SEC should not ignore the significant costs and economic effects that would result from the new proposed rules.
Lofchie Comment: Neither Commissioner Gallagher nor Commissioner Piwowar expressed much enthusiasm for the proposed new rule. It seems notable that the SEC thought it necessary to issue this 400-plus-page release so soon after issuing proposed Regulation SCI, in that its issuance further emphasizes the difficulties that regulated firms of all types have in attempting to keep up with the pace of new regulations.
To the extent that this rule is intended to prepare the clearing corporations for clearing equity swaps, the proposal wastes resources. The great benefits of central clearing remain unproven, but at least in plain-vanilla interest rate and index credit swaps, there is enough volume to support the effort of establishing and maintaining the clearing system. The existence of that much volume in most security-based swaps seems doubtful, so expending a great amount of governmental and private sector effort on building a clearing system for these swaps appears to be both wasteful and a distraction from more genuine issues.
See: Proposed Standards for Covered Clearing Agencies; Fact Sheet on Proposed Rule.
See also: Chair White’s Opening Statement; Commissioner Kara Stein’s Statement; Commissioner Piwowar’s Statement; Commissioner Gallagher’s Statement; Commissioner Aguilar’s Statement.
CFTC Acting Chairman Wetjen spoke at the International Futures Industry Conference discussing the need for a harmonized regulatory regime for global derivatives markets. Chairman Wetjen stated that, in order to achieve a harmonized regulatory regime, regulation must (i) “always be cognizant of reality” and (ii) be appropriately harmonized across legal jurisdictions. He went on to state: “The paramount objectives of derivatives regulations must be to support a global market structure that promotes open, transparent, and liquid markets and sound risk-management practices at the firms operating within those markets.”
Chairman Wetjen explained that global execution and clearing services should be open to U.S. persons, “provided the trading venues offering such services . . . are appropriately overseen by home regulators and remain subject to regulations that are comparable to, and as comprehensive as, U.S. law.” He argued further that this comparability standard incentivizes foreign jurisdictions to “harmonize their risk management, reporting, clearing, and execution standards with U.S. standards under Dodd-Frank,” and, over time, to better align the interests of firms operating in various jurisdictions with the regulatory interests of foreign regulators. Chairman Wetjen expressed his confidence that “an expanded comparability framework for global execution and clearing venues will translate, over time, into more competition and more “open, transparent, and liquid derivatives markets.”
Additionally, Chairman Wetjen encouraged foreign regulators to remain “faithful” to the outcomes-based approach described in the CFTC’s cross-border guidance. He stated that the CFTC staff is developing regulations to set forth a process for recognizing foreign clearinghouses and trading venues. These new regulations, he noted, will assist in pursing more “open, transparent, and liquid derivatives markets.” In closing, he declared that the CFTC will continue to promote harmonized regulation, doing what it can to avoid incentivizing personnel decisions, inter-affiliate relationships and corporate structures that will only make financial firms more difficult to manage, understand and unwind during a period of market distress.
Lofchie Comment: By his remarks, Commissioner Wetjen may be developing the groundwork for revisiting the cross-border “guidance” promulgated under former the former CFTC Chairman. While this is a good development, it is still important to question fundamental principles underlying Dodd-Frank. For example, it is not beyond dispute that centralized clearing reduces risk. If the U.S. regulators believe that the centralized clearing of certain products can reduce risk in the U.S. markets, it ought not follow that non-U.S. regulators should be obligated to reach the same conclusion.
Further, as we previously observed, both buy-side and sell-side market participants seem to find the U.S. regulatory approach unattractive (see related item in today’s news). This should give the U.S. regulators some pause before they seek to impose the U.S. regulatory framework globally.
See: Commissioner Wetjen’s Speech.
Related news: Commissioner Piwowar Speaks about International Financial Regulatory Issues (March 7, 2014); Chamber of Commerce Submits Amicus Brief Regarding Lawsuit against CFTC Cross-Border Rule (February 5, 2014).