Monthly Archives: February 2015

FIA and FIA Europe Issue Third Report in a Series Covering ESMA MiFID II Regulations

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The Futures Industry Association (“FIA”) and FIA Europe issued the third in a series of special reports that cover technical requirements on MiFID II regulations by the European Securities Markets Authorities (“ESMA”).

The third special report provides an overview of ESMA’s proposals in its December 19, 2014 Consultation Paper and the draft Regulatory Technical Standards on (i) post-trading issues for derivatives, (ii) indirect clearing and (iii) post-trade transparency requirements.

The MiFID II regulations will become effective on January 3, 2017.

See: Third Special Report: Derivatives under MiFID II – Part 2.
Related news: FIA and FIA Europe Issue Their Second Report in a Series Covering ESMA MiFID II Regulations (January 23, 2015); FIA and FIA Europe Issue First in a Series of Special Reports Regarding Summaries of ESMA MiFID II Regulations (January 16, 2015).

 

BATS Files Market Structure Rulemaking Petition with the SEC and Sends Letter to the Public

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BATS Global Markets (“BATS”) filed a petition for rulemaking with the SEC regarding Regulation NMS market structure reform, and issued a letter to market participants asking them to participate in a “constructive dialogue” intended to improve U.S. equity markets.

The petition, which was sent to the SEC on January 21, 2015, requests that the SEC adopt amendments to Regulation NMS Rules 600, 605, 606 and 610, as well as the consolidated tape plan in Rule 608. The petition focuses on three measures that BATS believes will improve the equity markets: (i) reducing access fees generally, (ii) requiring firms to provide greater transparency as to their order handling procedures, and (iii) eliminating benefits provided to small exchanges.

In the petition, BATS advocated for tiered access fees, starting at $.0005 for the most liquid securities. Tiered access fees, BATS contends, offer a “meaningful incentive” for liquidity providers to display quotes on narrow spreads. BATS also stated that Rules 605 and 606 should be amended to require ATSs to provide customers with their rules of operation, including disclosure of achieved execution quality on a broker-by-broker basis.

BATS also encouraged the SEC to revise Regulation NMS to stipulate that until an exchange or other currently protected market center achieves greater than 1% share of CADV in any rolling three-month period, it must (i) no longer be protected under the trade-through rule, and (ii) not share in or receive any NMS plan market data revenue.

In its open letter to securities industry participants, BATS stated that it is seeking feedback from market participants to create a consensus for market structure reform. Topics discussed in the letter included the following:

  • a greater than 80% fee reduction in the access fee cap for the most liquid securities, and a tiered approach to access fee reductions for less-liquid securities, benefiting issuers and investors;
  • greater standardized transparency into broker order routing and ATS order handling;
  • the implementation of a threshold of 1% market share before a market is considered protected under Regulation NMS or is eligible to participate in the national market system plans – a standard which would reduce fragmentation and market complexity;
  • the elimination of the current one-size-fits-all approach to equity market structure; and
  • the reduction of additional market complexity, such as that which is caused by federally mandated routing practices (e.g., Trade-At) or anti-competitive pricing restrictions (e.g., the ban on “Maker Taker”).

Lofchie Comment: Philosophically, the BATS letter reflects the viewpoint that the markets will work better based on (i) good disclosure and (ii) individual investor decision making, as opposed to governmental decision making. A rebuttal to this argument hinges on proving (or at least asserting) that, over the long run, decisions made by individuals result in a worse aggregate outcome than choices made by the government. It is not an impossible argument to make, but in the case of NMS, neither is it an easy one, since many of the most significant problems of the current market structure (particularly market fragmentation) can be traced to the dictates of NMS.

See: BATS Petition to the SEC; BATS Open Letter to Market Participants.

SEC and FINRA Issue Cybersecurity Publications

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The SEC and FINRA issued observations, suggestions and recommendations in separate publications to assist broker-dealers, investors and financial firms in developing best practices for handling cybersecurity risk.

The SEC Office of Compliance Inspections and Examinations issued a Risk Alert that contains preliminary observations based on examinations of the information technology and cybersecurity practices of over 100 broker-dealers and investment advisers. Additionally, the SEC Office of Investor Education issued an Investor Bulletin that offers suggestions to investors for minimizing cybersecurity risk with regard to their online brokerage, banking and other financial accounts, including the following: (1) in each case, pick a strong password that is unique to that online account; (2) utilize two-step verification processes for logging into accounts; and (3) ensure that wireless connections, including home networks, are “secure.”

In addition to a related Investor Alert, FINRA also issued a Report that contains detailed suggestions to broker-dealers for minimizing cybersecurity risk. The FINRA Report is based on information that was collected from a cross-section of financial firms in 2014. Its conclusion is that the importance of minimizing cybersecurity risk will continue to grow for broker-dealers in the coming years.

See: SEC Risk Alert; SEC Investor Bulletin; FINRA Report; FINRA Investor Alert; SEC Press Release; FINRA Press Release.

The Morgenthau Diaries Are Online

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Henry Morgenthau, Jr. was Secretary of the Treasury from 1934 to 1945, a period that of course included the 1944 Bretton Woods conference. Fortunately for historians, he was a compulsive chronicler. His collection of speeches, memos, transcripts of meetings, and other documents, termed the Morgenthau Diaries, runs to hundreds of volumes. They have been available for some years on microfilm, but at a price so high that few libraries have them. Now the diaries are are available for free online. They offer inside perspective on a tumultuous period of American and world history.

Morgenthau was the president of the Bretton Woods conference and the head of the U.S. delegation to the conference, and his diaries from that period (July 1-22, 1944) contain transcripts of many of the delegation’s meetings behind closed doors. The American delegates could be blunt in their private assessments, as these words from a July 1 meeting show:

MR. [Harry Dexter] WHITE: Those are the large countries. The smaller countries all want larger quotas. The most troublesome will be Australia, who is participating to an extent far beyond the proper role of a country of her size and importance. But they are going to insist on a larger quota and some other things that I suggested before.

Readers interested in Bretton Woods will find much to instruct and occasionally amuse them. Among other things, the diaries show clearly that Federal Reserve chairman Marriner Eccles, who is not recorded as having said a word in the conference sessions, was highly active behind the scenes.

At Bretton Woods the United States was at the zenith of its relative economic power, as the leading economy whose home territory was nearly untouched by the enemy. The attitude of the American delegation reflects its awareness of that fact. Reading the diaries, though, one must that remember that however fascinating they are, they are but a part of the story. What the Americans wanted was not always what transpired in conference, and their private scheming had counterparts in the private scheming of other delegations, which is less well recorded but which has recently received scrutiny from assiduous researchers.

(Hat tip to Eric Rauchway, who spoke at the 2014 CFS Bretton Woods conference.)

Associations Submit Comments on FSB Proposal Relating to Total Loss Absorbency Requirement on G-SIBs

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The Clearing House, SIFMA, the American Bankers Association and the Financial Services Roundtable (collectively, the “Associations”) provided comments in response to a proposal by the Financial Stability Board (“FSB”) to impose a total loss-absorbing capacity (“TLAC”) requirement on global systemically important banking groups (“G-SIBs”).

In the letter, the Associations expressed their support for a TLAC requirement for G-SIBs, stating that it is a “critical step” toward ending “Too Big to Fail.” However, the Associations indicated that a number of aspects of the proposal require modification and stressed the importance of ensuring that the requirement will be calibrated empirically to achieve its policy objective.

The letter recommended, among other things, that the FSB both (i) identify and explain the standard it uses in calibrating TLAC and (ii) support its calibration against that standard with empirically based forward-looking stressed analyses, as well as analyses of losses experienced by large institutions historically.

See: The Associations’ Comment Letter; SIFMA Press Release.

 

New York Fed to Revise Process for Calculating Federal Funds’ Effective Rate

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The Federal Reserve Bank of New York (“New York Fed”) announced that it plans to transition the data source of the federal funds rate calculation process from data supplied by federal funds brokers to transaction-level data collected directly from depository institutions. According to the New York Fed, this sort of data collection “captures a greater share of federal funds activity than brokered data alone and provides a larger base of transactions for the calculation of the effective federal funds rate.”

In addition, the New York Fed announced that it is preparing to publish an additional overnight rate on its public Web site, which will be calculated based on both federal funds transactions and the Eurodollar transactions of U.S.-managed banking offices.

Changes in the calculation of the federal funds rate and the publication of the overnight bank funding rate will be implemented after revisions to a Federal Reserve data collection are completed, which is expected to take place within one year.

See: New York Fed Press Release.

 

FSOC Requests Information on the Asset Management Industry

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FSOC seeks comment as to whether asset management products and activities may pose potential risks to the U.S. financial system in the areas of liquidity and redemptions, leverage, operational functions, and resolution.

The body of the release is divided into four parts: one dealing with redemption rights, one dealing with leverage, a third with operational risk, and a fourth and final part on insolvency risk. The last part concerns not only the insolvency of the underlying investment funds, but also of the investment manager, suggesting that FSOC may still be considering whether investment managers could be deemed to be systemically significant.

Lofchie Comment: The combination of (i) the failure of the release to develop questions that are reasonably tailored to different market participants, (ii) the absence of transparency as to the “success” of Form PF and (iii) the implicit assumption that the government could dictate permissible investments even by private funds (or by private citizens who hire investment advisers) is discomforting.

First, many of the questions are so simplistic that they seem to indicate that the government has a starting knowledge level of close to zero. Beyond that, the questions cover too much ground both in terms of their scope and in terms of the types of funds that they cover. FSOC should develop different forms of questions that would be relevant to different types of funds. Does it really make sense to send the same questions to SEC-registered investment companies, to private equity funds and to commodity pools that trade futures? Further, as to SEC-registered investment companies, shouldn’t most of the information already be available from the SEC?

Second, Form PF, was “intended” to collect information of the type requested by this Notice. Several times the government has commented on the high value of the information collected by Form PF. If that information is so valuable, why is the government requesting in this Notice the same very basic information. Perhaps, it is because Form PF is an incredibly expensive, yet totally worthless, information gathering effort; most of the questions with respect to financing make no sense. Until the government provides real information as to the results (or lack thereof) provided by Form PF, it is not appropriate for the government to embark on another massive information-gathering exercise.

Third, the language in the Notice suggests that the government could impose rules that dictate permissible investments or investment strategies of private funds. For example, the government could require private funds to hold assets in cash or in U.S. government securities. The Notice states that investment advisers “may not always manage investment vehicles in a way that prevents or fully mitigates the risks to . . . the broader financial system.” (at page 9). Is FSOC suggesting that private investors are going to be subject to regulations dictating how much of their assets are to be held in cash, or that their investment advisers manage assets for the purpose of protecting the financial system (perhaps by prohibiting asset sales in a down market)? The government already has many ways to control leverage of private funds; for example, through government regulation of the banking system, of broker-dealers, of FCMs, and so on.

See: FSOC Requests Comment on Asset Management Products and Activities.

Senator Warren and Representative Cummings Request Information from Banks Regarding Swaps Trading Practices

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U.S. Senator Elizabeth Warren (D-MA) and House Representative Elijah E. Cummings (D-MD) sent letters to multiple banks, requesting information about how the institutions will alter their swaps trading practices in response to the passage of Section 630 of the 2015 Consolidated and Further Continuing Appropriations Act (“Section 630”) (i.e., the amendments to the swaps “push-out” requirements of Section 716 of Dodd-Frank).

In the letter, Senator Warren and Rep. Cummings requested information from the banks so as to “aid in our oversight of the impact of Section 630.” Information requested includes:

  • the definition of the term “hedging” and “risk management purposes” that the firm will use to determine which swaps trades can now be made under Section 630;
  • the total value of derivatives contracts the institution holds for each of “hedging” and “risk management purposes,” and the total value of swaps derivatives contracts the institution holds for each of these purposes;
  • the types of transactions included in the term “structured finance swap” as used in Section 630, and the value of these transactions;
  • copies of the institution’s application to the Office of the Comptroller of the Currency to delay implementing Dodd-Frank Section 716;
  • a description of any “operation and credit risks” the institution would have experienced had it been required to implement the provisions of Section 716; and
  • the total value of swaps the institution would have “pushed out” under Section 716 absent the changes in Section 630, and the total value of swaps the institution now expects to “push out.”

Senator Warren and Rep. Cummings requested the information be provided by February 26, 2015, and request a briefing from an official of the institutions by February 19, 2015.

See: Senator Warren’s Press Release and Links to Letters.
Related news: Senate Approves Appropriations Bill Amending Swaps Push-Out Rule (December 15, 2014); Congress to Vote on Bill to Repeal Swaps Push-out Requirements (December 11, 2014).

 

FRB Proposes Rule to Expand Applicability of Small Bank Holding Company Policy Statement

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The Board of Governors of the Federal Reserve System (“FRB”) requested public comment on a proposed rule to expand the FRB’s Small Bank Holding Company Policy Statement (the “Policy Statement”) to apply to bank holding companies and savings and loan holding companies with total consolidated assets under $1 billion that satisfy the qualitative requirements specified in the Policy Statement. Institutions covered by the Policy Statement are exempt from the FRB’s regulatory capital requirements.

The proposed rule would also exempt such institutions from quarterly consolidated financial reporting requirements (FR Y-9C), and instead require parent-only financial statement reporting (FR Y-9SP). Savings and loan holding companies with total consolidated assets under $500 million that satisfy the qualitative requirements of the Policy Statement would be exempt from FR Y-9SP reporting.

In addition, the FRB adopted an interim final rule to exclude savings and loan holding companies with total consolidated assets under $500 million that satisfy the qualitative requirements of the Policy Statement from the FRB’s regulatory capital requirements. This treatment of savings and loan holding companies parallels the FRB’s current treatment of bank holding companies under the Policy Statement.

Comments on the proposed and interim final rule are due by March 4, 2015.

See: Proposed Small Bank Holding Company Policy Statement; Interim Final Rule to Exempt Small Savings and Loan Holding Companies from Regulatory Capital Rules; FRB Press Release.

 

President and CEO of the Federal Reserve Bank of Boston Discusses Cybersecurity and Cyber Threats

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President and CEO of the Federal Reserve Bank of Boston, Eric S. Rosengren, delivered remarks at the Bank for International Settlements High-level Meeting for Africa, emphasizing that cybersecurity is an important regulatory priority and a “serious financial stability concern.”

Mr. Rosengren stated that an immediate cybersecurity threat could focus an attack on payment systems, aiming to disrupt transactions rather than to obtain financial gain. According to Mr. Rosengren, this sort of attack would reduce consumer confidence.

Mr. Rosengren encouraged market participants, both private and public, to share “actionable” information as to cybersecurity roles and responsibilities and increase a firm’s preparedness.

See: Eric S. Rosengren Remarks.