US Regulatory Update
Department of the Treasury Releases Second Report Pursuant to President Trump’s February “Core Principles” for Financial Regulation Executive Order
On 6 October, the U.S. Department of Treasury published its second report in response to President Trump’s February 2017 Executive Order setting forth “Core Principles” for U.S. financial regulation. Patomak Global Partners recently published an in-depth review of this report, which focuses on capital markets. Treasury’s report provides several categories of policy recommendations, including: (i) expanding access to capital markets; (ii) equity market structure; (iii) the U.S. Treasuries market; (iv) corporate bond market liquidity; (v) securitization; (vi) derivatives markets; (vii) financial market utilities; (viii) regulatory processes; and (ix) issues related to international aspects of capital markets regulation. The report also explains that two additional Treasury reports will be published pursuant to President Trump’s Core Principles Executive Order – reports on: (i) “asset management and insurance industries, and retail and institutional investment products and vehicles”; and (ii) “nonbank financial institutions, financial technology, and financial innovation.” Along with its report, Treasury published a fact sheet for the seven categories of recommendations.
House Committee on Financial Services Passes 22 Bills
On 12 October, the U.S. House Committee on Financial Services passed 22 bills aimed at helping smaller banks, credit unions, and emerging growth companies. The Committee posted vote totals and summaries of each of the 22 bills passed, including:
- H.R. 3857, the PASS Act of 2017, which was passed by a vote of 34-26, and would repeal the Department of Labor’s (“DOL”) Fiduciary Duty Rule, replacing it with a uniform “best interest” standard under SEC jurisdiction.
- H.R. 3312, the Systemic Risk Designation Improvement Act of 2017, which was passed by a vote of 47-12 and would, among other things, “remove the arbitrary $50 billion asset threshold used to designate [bank holding companies] as ‘systemically important financial institutions’ and subject them to enhanced regulatory standards.”
- H.R. 3948, the Protection of Source Code Act, which was passed by a vote of 46-14, and would “require the SEC to first issue a subpoena before compelling a person to produce or furnish to the SEC algorithmic trading source code or similar intellectual property.”
- H.R. 3973, the Market Data Protection Act of 2017, which was passed by a vote of 59-1, and would “require that the SEC, FINRA, and the operator of the Consolidated Audit Trail (CAT), in consultation with the SEC’s Chief Economist, develop comprehensive internal risk control mechanisms to safeguard and govern the storage of market data, all market data sharing agreements, and all academic research using market data…and halt market data reporting to the CAT until the operator of the CAT develops such internal risk control mechanisms.”
- H.R. 1116, the TAILOR Act of 2017, which was passed by a vote of 39-21 and would require federal financial regulatory agencies to: (i) “to tailor their rulemakings in consideration of the risk profiles and business models of institutions that are subject to such rules”; and (ii) “report to Congress and testify regarding the specific actions taken to tailor their regulatory actions.”
- H.R. 1585, the Fair Investment Opportunities for Professional Experts Act, which was passed by a vote of 58-2, and would amend the definition of accredited investor in the Securities Act of 1933 to include: (i) “persons whose individual net worth, including their spouse’s, exceeds $1,000,000, excluding the value of their primary residence”; (ii) “persons with an individual income greater than $200,000, or joint income with one’s spouse greater than $300,000”; (iii) “persons with a current securities-related license”; and (iv) “persons whom the [SEC] determines have demonstrable education or job experience to qualify as having professional subject-matter knowledge related to a particular investment.”
- H.R. 2121, the Pension, Endowment, and Mutual Fund Access to Banking Act, which was passed by a vote of 60-0, and would specify “that a custodial bank shall exclude central bank placements from the calculations to determine the applicable supplementary leverage ratio.”
- H.R. 3903, the Encouraging Public Offerings Act of 2017, which was passed by a vote of 60-0, and would “allow issuers to submit to the SEC for confidential review, before publicly filing, draft registration statements for Initial Public Offerings (IPOs) and for follow-on offerings within one year of an IPO.” This bill mirrors, and would codify provisions of, the SEC’s Division of Corporation Finance recent action setting forth “Draft Registration Statement Processing Procedures.”
SIFIs & FINANCIAL STABILITY
U.S. National Economic Council Director Gary Cohn Indicate Consensus to Increase $50 Billion Bank SIFI Threshold
On 16 October, Reuters reported that U.S. National Economic Council Director Gary Cohn, speaking at the American Bankers Association conference, “expressed confidence” that Congress would increase the $50 billion threshold for designating a bank holding company as a systemically important financial institution (“SIFI”). Cohn stated that he would support raising the threshold to “any level above $200 billion” or having a risk-based threshold. While the $50 billion threshold for bank holding companies does not directly apply to nonbank entities, the FSOC considers the existing $50 billion threshold as part of its nonbank SIFI designation process.
U.S. National Economic Council Director Gary Cohn Expresses Agitation with the Lack of “Proper” Guardrails and Resolution Guidelines at Clearinghouses
On 15 October, the Wall Street Journal reported that National Economic Council Director Gary Cohn, at a Group of 30 banking seminar panel, told the audience that he “[does not] think we have guidelines about how to resolve a clearinghouse in an orderly fashion.” Director Cohn also noted that the role of clearinghouses, made more significant due to the Dodd-Frank Act’s central clearing mandate for many previously uncleared derivatives, “agitates” him. He expressed his concern that he “[does not] think we really understand the magnitude of continuously putting things in clearinghouses without the proper guardrails in the clearinghouse,” and commented that “we have expanded the limits of clearing probably farther beyond their useful existence.”
SEC & SECURITIES
SEC Proposes Rules to Implement FAST Act to Modernize and Simplify Disclosure
On 11 October, the SEC voted unanimously to propose amendments to Regulation S-K based on recommendations made in the SEC staff’s report on modernizing and simplifying Regulation S-K and as required by the 2015 Fixing America’s Surface Transportation Act. The prosed amendments would, according to the SEC’s fact sheet on the SEC proposal: (i) “modernize and simplify certain disclosure requirements in Regulation S-K”; and (ii) “improve the readability and navigability of disclosure documents and discourage repetition and disclosure of immaterial information.” As the fact sheet explains, the “proposal also includes parallel amendments to several rules and forms applicable to investment companies and investment advisers, including proposed amendments that would require certain investment company filings to be submitted in HyperText Markup Language (HTML) format.” The comment period will close 60 days after publication of the proposed amendments in the Federal Register.
SEC Chairman Jay Clayton Provides Update on Cyber Breach of EDGAR
On 2 October, SEC Chairman Jay Clayton provided an update on the status of the SEC’s investigation into the 2016 cyber breach of its Electronic Data Gathering, Analysis, and Retrieval (“EDGAR”) system. In his statement, Chairman Clayton explained that the investigation has “determined that an EDGAR test filing accessed by third parties . . . contained the names, dates of birth and social security numbers of two individuals” and that the SEC has reached out to the individuals to provide “identity theft protection and monitoring services.” He went on to describe the Commission’s efforts going forward to address the cyber breach, and also announced that he has: (i) “authorized the immediate hiring of additional staff and outside technology consultants” to assist the SEC in enhancing its information security; (ii) directed staff to “strengthen the agency’s cybersecurity risk profile, with an initial focus on EDGAR . . . and conduct similar reviews of other systems in use at the SEC”; and (iii) directed staff “to enhance escalation protocols for cybersecurity incidents.”
House Committee on Financial Services Hearing Examines the SEC’s Agenda, Operations, and Budget
On 4 October, the U.S. House Committee on Financial Services held a hearing to examine the SEC’s agenda, operations, and budget. SEC Chairman Jay Clayton testified on issues related to, among others: (i) the cyber breach of the SEC’s EDGAR system; (ii) the DOL’s Fiduciary Duty Rule; (iii) the consolidated audit trail (“CAT”); (iv) the Markets in Financial Instruments Directive (“MiFID II”); (v) the regulation of asset managers and SIFI designations; (vi) initial public offerings (“IPOs”); (vii) market structure; (viii) Rule 30e-3, regarding electronic delivery; and (ix) exchange traded funds (“ETFs”).
- Cyber Breach of the SEC’s EDGAR System: SEC Chairman Clayton responded to multiple questions from Committee members regarding what actions the SEC will take to enhance its cybersecurity defenses. Clayton stated that the SEC would not “wait until the end of the five work streams” he announced on 2 October 2017 to take action, the SEC is currently reviewing its incident response plan to identify areas for improvement, and he is now actively searching for a Chief Risk Officer (“CRO”) for the SEC. When questioned by Rep. Maxine Waters (D-CA) as to whether the SEC has adequate resources to address its deficiencies, Chairman Clayton stated that going forward he will ask for a seven percent increase in funding for fiscal year 2019, a significant portion of which would be used to enhance cybersecurity and market integrity, as well as to address retail fraud. When questioned by Rep. Ed Royce (R-CA) as to how Clayton intends to define the responsibilities of the new CRO, Clayton stated that the SEC needs a position that can look at the SEC’s risk profile “across the organization” and “across the [SEC’s] divisions.”
- DOL Fiduciary Duty Rule: Rep. Ann Wagner (R-MO) discussed her bill, H.R. 3857, the PASS Act of 2017, which would replace the DOL’s Fiduciary Duty Rule with a uniform best interest standard for broker-dealers and asked Chairman Clayton how important it is to ensure that there is not a “bifurcated regulatory regime” between the DOL and SEC. Clayton stated that there should be consistency instead of “asymmetric standards” between the two agencies, and thanked DOL Secretary Alexander Acosta for reaching out and cooperating on this issue. Rep. Wagner then noted the recent law enacted by the state of Nevada that implemented its own state-level fiduciary standard and questioned whether Chairman Clayton is concerned about the potential impacts of a “patchwork” of state-level standards. Clayton responded that he is concerned. When questioned by Rep. Wagner regarding what the SEC’s next steps would be regarding this issue, Clayton stated that the SEC is working on a rule proposal in coordination with the DOL.
- CAT: When questioned by Committee Chairman Jeb Hensarling (R-TX) as to whether the CAT is ready for “prime time” and related “outstanding cybersecurity concerns have been ameliorated,” Chairman Clayton responded that the SEC has two roles related to the CAT: (i) an oversight role of the self-regulatory organizations involved in setting up the CAT; and (ii) a beneficiary of the CAT once it is live in the sense that the SEC gets its data. Chairman Clayton stated that the SEC would not acquire sensitive information from the CAT unless he is satisfied that the SEC needed the information and could protect the information, but expressed that those “not yet been answered to [his] satisfaction.” When questioned by Rep. Bill Huizenga (R-MI) as to whether the self-regulatory organizations (“SROs”) and SEC are waiting for each other to declare that the CAT is not yet ready for implementation, Clayton stated that SROs have an obligation to ensure that the CAT becomes operational, including its cybersecurity functions, but that the SEC will not acquire any data until he is satisfied with the security of the information. When questioned by Rep. Joyce Beatty (D-OH) as to whether it is necessary for the SEC to collect personally-identifiable information (“PII”) through CAT, Clayton stated that the collection of PII can be necessary, citing the identification of individuals in insider trading cases as an example. When questioned by Rep. Randy Hultgren (R-IL) as to whether Clayton believes Thesys is taking the “appropriate steps to secure the information that will be stored within the CAT” and what the SEC’s role should be in overseeing this, Clayton stated the “first line of security is with the SROs” and that he intends to “press them…in detail” on whether the security procedures in place for the CAT are appropriate.
- MiFID II: When questioned by Rep. Huizenga as to whether the SEC intends to “provide formal relief or guidance” to address conflicts between MiFID II and the U.S. regime, Clayton stated that the SEC wants to ensure that the EU cannot “directly or indirectly, force the importation of that system” into the U.S. and that the “current model” be allowed to continue. When questioned by Rep. Dennis Ross (R-FL) as to whether the SEC intends to adopt measures to address issues that the implementation of MiFID II could cause for small and medium-sized U.S. firms, Clayton reiterated that he wants to ensure that the U.S. model does not “import” the EU model and that the SEC is considering a “patchwork of exemptive relief.”
- Regulation of Asset Managers and SIFI Designations: When question by Rep. Andy Barr (R-KY) as to whether the SEC should delay the effective date of a recently adopted regulation to require mutual funds to report portfolio-wide and position-level holdings data to the SEC on a monthly basis due to cybersecurity concerns, Clayton responded that this data would provide advantages to market participants if accessed and that the SEC is examining this issue. When questioned by Rep. Ross as to whether the SEC is “more than competent” to regulate asset managers without the “interference” of FSOC SIFI designations, Clayton agreed, stating that “this is our space.”
- IPOs: When asked by Committee Chairman Hensarling to provide his opinion regarding “chilling effects of regulations” on the initial public offering (“IPO”) market and why it is important to “reinvigorate” this market, Clayton responded that “the most efficient way for retail investors to invest is in our public capital markets” and that the “choices available to retail investors are…diminishing because the number of public companies is diminishing.” Clayton also noted that one factor behind the decline in the number of public companies is a “one-size-fits-all” regulatory model that applies large company requirements on all companies and that the JOBS Act and emerging growth companies demonstrate that a “scaled system” is “something we should be looking at.” When questioned by Rep. Keith Ellison (D-MN) as to whether the decline in IPOs has been a result of large companies purchasing smaller companies, Clayton stated that this is a factor, and that the “path of least resistance and maximum return” may incentivize smaller companies to sell themselves to larger companies.
- Market Structure: When questioned by Rep. Huizenga as to whether both the Committee and the SEC should conduct a “holistic” review of the equity market structure and whether the focus should be on Regulation National Market System (“Reg NMS”) or a broader range of topics, Clayton stated that it was important to review Reg NMS, but that the broader questions must be considered as well. When questioned by Rep. Mia Love (R-UT) regarding the status of the tick size pilot, Clayton stated that results have been “mixed” and that the SEC’s economists believe that they need more time to determine whether the data they have gathered is useful. When questioned by Ranking Member Carolyn Maloney (D-NY) as to whether the access fee pilot would contain a “bucket with zero-rebates,” Clayton stated that a zero-rebate bucket is under consideration and he has discussed this issue with the SEC staff.
- Rule 30e-3: When questioned by Rep. Brad Sherman (D-CA) when the proposed Rule 30e-3, which would allow financial disclosures to be delivered electronically, would be finalized, Clayton stated that the SEC is working on the rule.
- ETFs: When questioned by Rep. French Hill (R-AR) about whether the SEC should adopt a rule establishing the process for approving ETFs as opposed to using “exemptive relief” to grant approval, Clayton stated that the SEC should not adopt a one-size-fits-all approach in approving and regulating ETFs, but declined to comment on how the SEC would regulate ETFs going forward.
SEC Approves FINRA Proposal to Restructure Qualification Examinations
On 5 October, the Financial Industry Regulatory Authority (“FINRA”) issued a Regulatory Notice indicating that the SEC had approved FINRA rule proposals aimed at, among other things, restructuring FINRA’s qualification examinations. Under the new rules, all new “representative-level applicants” are required to pass a newly-established general knowledge examination, the Securities Industry Essentials (“SIE”), and a revised version of current representative-level qualification examinations. FINRA’s Notice explains that the its restructured examination program will: (i) remove certain existing examinations to “eliminate duplicative testing of general securities knowledge . . . by moving such content into the SIE”; (ii) allow certain former and current registered representatives to “be considered to have passed the SIE”; and (iii) allow firms to request a “waiver of the qualification requirements for applicants required to pass the SIE.” The new rules will come into effect on 1 October 2018.
Senate Banking Committee will hold Hearing for Nomination of Hester Pierce and Robert Jackson as SEC Commissioners
On 16 October, the Wall Street Journal reported that the Senate Committee on Banking, Housing, and Urban Affairs is expected to hold a hearing on the nomination of Hester Pierce for a Republican Commissioner seat on the SEC and Robert Jackson for a Democratic Commissioner seat on the SEC.
CFTC & DERIVATIVES
House Committee on Agriculture Holds Hearing to Examine the CFTC’s 2017 Agenda
On 11 October, the U.S. House Committee on Agriculture held a hearing on examining the 2017 agenda for the CFTC. CFTC Chairman J. Christopher Giancarlo testified on issues related to, among others: (i) the de minimis threshold; (ii) cross-border regulatory deference; (iii) interagency cooperation; (iv) collection of sensitive information and cybersecurity; and (v) clearinghouses.
- De Minimis Threshold: During his initial testimony, Giancarlo announced that he has requested that the CFTC delay the reduction of the de minimis threshold for one year in order to give the incoming Commissioners and division staff “adequate time to analyze extensive quantitative data, ask questions, analyze the answers, and arrive at a final decision.” Additionally, Chairman Giancarlo announced that he intends “to put before the Commission in the first half of 2018 a proposal for a final resolution of the swap dealer de minimis issues” and that he does not intend to “roll over the decision on this issue again.” When questioned by Rep. David Scott (D-GA) as to whether Giancarlo would “pledge” not to lower the de minimis threshold from $8 billion, Giancarlo stated that he intends to find the right balance by analyzing “the latest and very best data” with the other CFTC Commissioners to ensure that the CFTC keeps the “amount of market-making going on in the markets” and that his goal is to “get to the right outcome.”
- Cross-Border Regulatory Deference: When questioned by Committee Chairman Mike Conway (R-TX) regarding the issues surrounding the EU’s efforts to impose its regulatory regime on other countries, Giancarlo explained that as a result of the United Kingdom’s vote to leave the EU, the EU is proposing a regime whereby EU regulators will have direct oversight of “third-country” clearinghouses, which in some cases, could result in the “export European substantive law into the way [U.S.] clearinghouses operate.” Chairman Giancarlo stated that the CFTC is working closely with European colleagues on these matters, but that the U.S. is “a sovereign nation and . . . [has] a sovereign approach to these rule implementations.”
- Interagency Cooperation: When questioned by Rep. Frank D. Lucas (R-OK) as to whether the SEC and CFTC should harmonize their rules regarding inter-affiliate margin as recommended by the U.S. Department of Treasury report released on 6 October 2017, and if so, how the two agencies could accomplish this, Giancarlo responded that he and SEC Chairman Jay Clayton have identified a “whole range of issues that deserve a considerable amount of high-level attention” for the two agencies to resolve, that they have established a “Chairman to Chairman ad hoc working group,” facilitated by their respective Chiefs of Staff, who meet several times a month, and will soon also be having weekly Chairman to Chairman meetings to address these issues.
- Collection of Sensitive Information and Cybersecurity: When questioned by Rep. Lucas regarding concerns surrounding the CFTC’s collection of sensitive information, especially with regards to Regulation Automated Trading (“Reg AT”) and the recent cyber breach of the SEC’s EDGAR, Chairman Giancarlo stated that he has instructed CFTC staff to: (i) catalogue the agency’s usage of personally-identifiable information ; (ii) identify where the CFTC can eliminate or reduce its collect of PII; and (iii) for PII that the CFTC determines is necessary to collect, determine best practices related to the handling of this information.
- Clearinghouses: When questioned by Rep. Sean Patrick Maloney (D-NY) regarding what “systemic concerns” Giancarlo currently has besides clearinghouses, Giancarlo stated that there “is always a concern about swaps when you combine the complexity and leverage” related to how these products are used, which is why he has put forward a proposal to license intermediaries and brokers in this market.
CFTC and European Commission Announce Comparability Determination for Margin Requirements of Uncleared Swaps and a Common Approach on Trading Venues
On 13 October, the CFTC and European Commission (“EC”) each announced comparability and equivalence determinations of margin requirements for uncleared swaps. These determinations will ensure that swap dealers and major swap participants that are subject to both CFTC and EC margin rules will be deemed to be in compliance with the other jurisdiction’s margin rules when it is in compliance with the host’s margin rules. The CFTC and EC also announced a common approach regarding the regulation of certain CFTC and EU derivatives trading venues. As noted by the release, the common approach aims “to ensure that EU counterparties are able to comply with the trading obligation under Article 28 of the Markets in Financial Instruments Regulation (“MiFIR”) by executing mandated derivatives on EU authorized trading venues or CFTC-authorized swap execution facilities ("SEFs") and designated contract markets (“DCMs”), while ensuring that US counterparties can comply with the trade execution requirement under the CEA by executing swaps on certain EU authorized trading venues that are exempted from SEF registration, as well as on SEFs and DCMs.” EC Vice President for the Euro and Social Dialogue, Financial Stability, Financial Services and Capital Markets Union Valdis Dombrovskis now intends to propose that the EC adopt “an equivalence decision to recognize CFTC-authorized SEFs and DCMs that operate in the United States as eligible venues for the execution of those derivatives transactions that will be subject to the EU trading obligation,” while CFTC staff “intends to propose, and the Chairman will support putting before his fellow Commissioners for a vote, the exemption by the CFTC of EU authorized swap trading venues . . . from the requirement to register with the CFTC as SEFs.”
CFTC Commissioner Quintenz Delivers Speech on Automated Trading, Distributed Ledger Technology, Bitcoin, and Cybersecurity
On 4 October, CFTC Commissioner Brian Quintenz delivered the keynote remarks before the Symphony Innovate 2017 Conference addressing issues related to, among other things: (i) Reg AT; (ii) distributed ledger technology (“DLT”); and (iii) cybersecurity.
- Regulation AT: Commissioner Quintenz criticized the rule for failing to properly distinguish between “automated trading” and “algorithmic trading,” emphasizing that “not all algorithmic trading strategies have completely automated functionality.” He argued that the “agency needs to reset its posture on this issue” and that he does not believe that the right answer is “to regulate and dictate all algorithmic trading activity.” Commissioner Quintenz also stated that the “prior administration’s massively over-reaching and highly concerning ‘source code repository’ proposal is D-E-A-D.”
- Bitcoin and Other Digital Assets: Commissioner Quintenz stated that the CFTC is working on a proposal to define “‘actual delivery’ of a virtual commodity” and expects to work with the Technology Advisory Committee (“TAC”) in order to “provide regulatory consistency with other commodities….as well as regulatory certainty within which a more constructive trading environment may develop.”
- Cybersecurity: Commissioner Quintenz emphasized the need to focus not only on the prevention of cyber breaches, but also on “mitigation and recovery” as well. He expressed the importance of the cybersecurity enhancements within the industry and stated that he would like the CFTC to “work with the private sector through the TAC to ensure [that the CFTC is] training [its] people according to the highest standards, on most recent threats, and at the appropriate intervals.” He also added that from “a FinTech perspective, many start-ups lack physical infrastructure and are cloud-dependent,” and accordingly, it is important to “explor[e] how the physical location density of back-up facilities and the concentration of cloud-based data providers raise or alleviate questions or around cloud resiliency.”
DOL FIDUCIARY DUTY RULE
DOL Files Request for Judicial Stay Against Thrivent Financial
On 13 October, the DOL filed a request to stay proceedings as part of Thrivent Financial’s lawsuit against the DOL over its Fiduciary Duty Rule and Best Interest Contract Exemption, as reported by Pensions & Investments. The filing argues that that the Court should stay proceedings “because it would conserve judicial resources to await completion of the department's pending administrative actions, which are likely to address the challenged provision before it becomes applicable.” The DOL is currently reviewing the comments it has received in response to its proposed regulatory action to delay the applicability date of certain aspects of the Fiduciary Duty Rule, including the Best Interest Contract Exemption, from 1 January 2018 to 1 July 2019. According to Pensions & Investments, the filing also stated that “the very fact that an extension is likely makes these alleged harms uncertain.”
UPCOMING EVENTS AND DEADLINES
- 18 October: CFTC Commissioners Rostin Behnam and Brian Quintenz will participate in a “fireside chat” at the 33rd Annual FIA Futures & Options Expo.
- 19 October: CFTC Commissioners Brian Quintenz and Kara Stein will participate in a “fireside cat” at the Georgetown University's First Annual Fintech Week.
- 23 October: CFTC Office of International Affairs 25th Annual Symposium.