CME Group published a white paper, titled “Clearing – Balancing CCP and Member Contributions with Exposures,” that details its position on a variety of issues facing central counterparty clearinghouses (“CCPs”).

Specifically, the paper considers the question of how much “skin in the game” CCPs should contribute to a market’s financial safeguards. In the opinion of CME Group, the “skin in the game requirements” must be developed according to principles that incentivize market participants to manage the risks they create.

Lofchie Comment: The recent healthy debate over the safety (or not) of central clearinghouses is a wonderful antidote to the fiction championed by those who argue that central clearing eliminates risk. Credit goes to JP Morgan for initiating the discussion.

See: “Clearing – Balancing CCP and Member Contributions with Exposures“; CME Group Press Release. 
Related news: JPMorgan Issues Paper on Resolution Plan for Central Clearing Parties (October 6, 2014).

The SEC adopted two new sets of rules (the “rules”) that will require security-based swap data repositories (“SDRs”) to register with the SEC and that prescribe the reporting and public dissemination of security-based swap transaction data.

The rules – Regulation SDR and Regulation SBSR – also set forth other requirements with which SDRs must comply, as well as provide an exemption from registration for certain non-U.S. SDRs when specific conditions are met.

Regulation SDR governs the registration process for security-based swaps data repositories, assigning duties and core principles, as well as data collection and maintenance obligations, to SDRs. The rules also require SDRs to designate a Chief Compliance Officer (“CCO”) with “meaningful responsibilities.”

Regulation SBSR provides for the reporting of security-based swaps information to registered SDRs, as well as the public dissemination of security-based swap transaction, volume and pricing information. In addition, the rules assign reporting duties for many security-based swap transactions and require SDRs registered with the SEC to establish and maintain policies and procedures for carrying out their duties under Regulation SBSR.

Under the rules, the SEC recognizes the Global Legal Entity Identifier System as the system from which security-based swap counterparties must obtain codes to identify themselves when reporting security-based swap data. The rules also address the application of Regulation SBSR to cross-border security-based swap activity and include provisions to permit market participants to satisfy their obligations under Regulation SBSR through compliance with the comparable regulation of a foreign jurisdiction.

The SEC also proposed additional rules, rule amendments and guidance related to Regulation SBSR and the reporting and public dissemination of security-based swap transaction data. These additional proposed rule amendments would:

• assign reporting duties for certain security-based swaps not addressed by the adopted rules;
• prohibit registered SDRs from charging fees to or imposing usage restrictions on the users of publicly disseminated security-based swap transaction data; and
• provide a compliance schedule for certain provisions of Regulation SBSR.

The adopted rules will become effective 60 days after their publication in the Federal Register. Persons who are subject to the new rules must comply with them no later than 365 days after the adopted rules are published in the Federal Register.

Lofchie Comment: These rule adoptions raise important questions about the exercise of power.

Under the rules adopted by the SEC majority, an SDR can only fire its CCO if the board of directors authorizes that action; however, the dissent argues that the board of directors should be able to delegate that power to the firm’s Chief Executive Officer or to other senior officers of the SDR. To those who work outside the private sector and are not familiar with the process by which such decisions are made, this dispute may seem to be mere quibbling over procedure. The larger philosophical issue is about “power”; that is, the SEC’s justification for (i) allocating to itself the power to determine the process by which a company’s CCO must be fired and (ii) overriding the authority of the firm’s board of directors to decide who should make that decision (and to grant the authority to make the decision to the firm’s chief executive officer), subject to the further authority of state corporate law.

Perhaps the SEC believes that its assumption of this power can be justified because SDRs are nothing but creatures created by federal law. However, as the SEC dissent points out, nothing in that federal law justifies this assertion of power by the SEC. Furthermore, the entities over which the SEC has determined to exercise such an unusual degree of authority are data repositories; that is, they are boring, tedious, humdrum utilities. Thousands of companies are more significant to the economy than data repositories, and thousands of companies offer more significant opportunities for wrongdoing. If the SEC thinks that it is justified in dictating the corporate governance process of a data repository, then why shouldn’t it assert even greater authority over the processes by which other businesses operate – including those of businesses that are a lot more important than data repositories (e.g., businesses that produce food or energy, or provide transport)?

Federal regulators should and do exercise a great degree of authority over financial institutions and over companies that offer their shares to the public. There must be vigilance, however, over ever increasing assertions of power by regulators.

Lofchie YouTube Selection on Super Powers.

See: SEC Press Release.
See also: Chair White’s Opening Statement; Commissioner Aguilar’s Statement of Support; Commissioner Piwowar’s Statement of Dissent; Commissioner Stein’s Statement of Support; Commissioner Gallagher’s Statement of Dissent.

The SEC announced an open meeting on January 14, 2015 at 10 a.m., Eastern Standard Time, to consider whether or not to adopt various rules concerning swap regulation.

Specifically, the SEC will consider whether to:

• adopt rules under the Exchange Act that govern the security-based swap data repository (“SDR”) registration process, the duties of such repositories, and the core principles applicable to such repositories;
• adopt “Regulation SBSR – Reporting and Dissemination of Security-Based Swap Information” (“Regulation SBSR”) under the Exchange Act to provide for the regulatory reporting of security-based swap information and the public dissemination of security-based swap transaction, volume and pricing information by registered SDRs; and
• propose certain new rules, rule amendments and guidance for Regulation SBSR under the Exchange Act to address, among other things, the reporting duties for cleared and platform-executed security-based swap transactions.

See: SEC Sunshine Act Meeting Notice.

After narrowly passing the House of Representatives on Thursday, the Consolidated and Further Continuing Appropriations Act of 2015 (the “Act”) was passed by the Senate on Saturday.

Preliminary bills leading up to the Act contained various financial regulatory reforms, including exemptions for small banks from both mortgage-underwriting standards and the Volcker rule, as well as a provision that would have subjected the Consumer Financial Protection Bureau to the Congressional appropriations process. Most of these reforms were omitted from the final text. The Act (Section 630 at page 615) amends Section 716 of Dodd-Frank (the “Swaps Push-Out Rule”), which requires insured depository institutions to “push out” certain swaps trading activities into legally separate, non-insured entities. As amended by the Act, the Swaps Push-Out Rule is limited to swaps based on asset-backed securities (and related indices) that are not used for hedging purposes (and are not otherwise permitted by prudential regulators).

In addition, the Act:

• Requires the Director of the Office of Management and Budget to submit a report concerning the implementation costs of Dodd-Frank (Section 202 at page 540);
• Provides that funds allocated to the Securities and Exchange Commission (the “SEC”) and the Commodity Futures Trading Commission (the “CFTC”) may be used to fund a joint, inter-agency advisory committee (Section 617 at page 609); and
• Establishes a budget of $1.5 billion for the SEC (up $150 million from the prior fiscal year) (at page 594) and $250 million for the CFTC (up $35 million from the prior fiscal year) (at page 565).

Lofchie Comment: Section 716 (commonly known as the Swaps Push-Out Rule or the Lincoln Amendment) was, by all reports, inserted into Dodd-Frank in opposition to the views of even the most enthusiastic supporters of the legislation at the insistence of then Senator from Arkansas, Blanche Lincoln, as the price of gaining her support. She appeared to believe that the provision would help her in her upcoming election. She lost the election but her provision survived, in spite of the fact that it had neither support nor the least evidence provided for its usefulness. By largely striking Section 716, Congress deleted what was arguably the single worst provision in Dodd-Frank (although there remains lots of fixes that should be made), one that would have been quite damaging to the U.S. economy, and that did not even help Senator Lincoln win her election.

See: Consolidated and Further Continuing Appropriations Act, 2015.
See also: Streetwise Professor: The Height of Absurdity: The Operation of the Government Hinges on Blanche Lincoln’s Brainchild
Related news: Congress to Vote on Bill to Repeal Swaps Push-out Requirements (December 11, 2014).

The U.S. Congress is scheduled to consider a proposal to allow banks to keep swaps trading units.

The congressional vote on the proposal, which is included in the government funding bill (H.R. 83), will take place soon.

Regarding the bill, FDIC Vice Chair Hoenig stated that “[i]t is illogical to repeal the 716 push out requirement,” and explained that most derivatives would not even be pushed out of the bank because “interest rate swaps, foreign exchange and cleared credit derivatives can remain within the bank.”

According to Vice Chair Hoenig, the main items that must be pushed out under Dodd-Frank Section 716 are uncleared credit default swaps, equity derivatives and commodities derivatives, which are “much smaller and where the greater risks and capital subsidy is most useful to these banking firms.” Additionally, he stated, the derivatives that are pushed out are “only removed from the taxpayer support and the accompanying subsidy of insured deposit funding – they will continue to exist and to serve end users.”

Lofchie Comment: There are good reasons to repeal Section 716. It is wasteful and expensive for banking organizations to have to build an infrastructure to support swaps-dealing activity in more than one legal entity. This requires a duplication of regulatory expenses, a substantial duplication of technology infrastructure and a significant increase in necessary personnel. Additionally, banking organizations face the same customers in both types of transactions. By forcing banking organizations to split their transactions between two legal entities, the regulations diminish the ability of the banks to reduce credit exposure by netting off transactions with a single customer. Similarly, banking organizations face more operational burdens when moving margin payments back and forth between entities as a customer’s positions change in value at separate entities. Contrary to Vice Chair Hoenig’s view that banks will continue to provide these services to end users, it follows that banks will provide fewer of the services at a higher cost. (These requirements are not cost-free, nor are they internalized by the banking system; they have to be passed on to users, such as the commercial firms that trade in commodities.)

Banks are well suited to engage in these activities. Lending money with respect to debt obligations or commodities, whether the exposure is documented as a loan or as a derivative, is inherently a credit function and, thus, an activity appropriate for banks.

See: H.R. 83; Vice Chair Hoenig’s Statement.