US Regulatory Update
Department of the Treasury Releases Third Report Pursuant to President Trump’s February “Core Principles” for Financial Regulation Executive Order
On 26 October, the U.S. Department of Treasury published its third report in response to President Trump’s February 2017 Executive Order setting forth “Core Principles” for U.S. financial regulation. This report focused on asset management and insurance, and “identified significant opportunities for reform consistent with the Core Principles” related to: (i) “ensuring appropriate evaluation of systemic risk and solvency”; (ii) “promoting efficient regulation and rationalizing the regulatory framework to decrease regulatory burdens and maximize product and service offerings”; (iii) ”rationalizing U.S. engagement in international forums to promote the U.S. asset management and insurance industries, and encourage firm competitiveness”; and (iv) “enhancing consumer access to a variety of relevant products and services.”
- Asset Management: The Treasury’s report provides several categories of policy recommendations, including: (i) “systemic risk and stress testing,” in which Treasury endorses “eliminate[ing] the stress testing requirement for investment advisers and investment companies”; (ii) “liquidity risk management,” in which Treasury “rejects any highly prescriptive regulatory approach to liquidity risk management,” such as bucketing requirements, and instead “supports the SEC adopting a principles-based approach to liquidity risk management rulemaking”; (iii) “derivatives,” in which Treasury urges the SEC to reconsider what, if any, derivatives portfolio limits it should establish through rulemaking; (iv) “exchange traded funds,” in which Treasury recommends that “the SEC move forward with a ‘plain vanilla’ ETF rule that allows entrants to access the market without the cost and delay of obtaining exemptive relief orders”; (v) “business continuity and transition planning” in which Treasury expresses its belief that “there is no compelling need for additional rulemaking in this area”; (vi) “dual CFTC and SEC registration,” in which Treasury recommends that the CFTC amend its rules so that “an investment company registered with the SEC and its adviser are exempt from dual registration and regulation by the CFTC as a [commodity pool operator]”; (vii) “modernizing the delivery of fund disclosures”; (viii) “asset management reporting and disclosure requirements”; (ix) the Volcker rule, in which Treasury calls upon agencies to further reduce the rule’s burdens through a number of regulatory and enforcement steps; (x) “international engagement”; and (xi) “economic growth and informed choices,” in which Treasury recommends “delay[ing] the full implementation of the Fiduciary Rule until the relevant issues . . . are evaluated and addressed to best serve investors.”
- Insurance: The Treasury’s report provides several categories of policy recommendations, including: (i) “systemic risk and the insurance industry,” in which Treasury recommends that “insurance regulators . . . focus on potential risks arising from insurance products and activities” rather than conducting “entity-based systemic risk evaluations of insurance companies”; (ii) “preserving solvency: capital initiatives,” in which Treasury recommends that “the group capital initiatives by the [National Association of Insurance Commissioners (“NAIC”)], the states, and the Federal Reserve . . . be harmonized”; (iii) “preserving solvency: liquidity initiatives,” in which Treasury “encourages state insurance regulators, the NAIC, and the Federal Reserve to continue their work on addressing potential liquidity risk in the insurance sector”; (iv) “role of state and federal regulation,” in which Treasury commits to increasing the “transparency and stakeholder engagement [of the Federal Insurance Office (“FIO”)]”; (v) “terrorism risk insurance program”; (vi) “insurer data security”; (vii) “insurer cyber threats”; (viii) “product approval and speed to market”; (ix) “producer licensing and appointments”’; (x) “regulatory structure and issues of duplication, overlap, and fragmentation,” in which Treasury calls upon “federal agencies and entities [to] establish formal mechanisms to promote coordination and communication across the federal government with respect to insurance-related issues”; (xii) “multilateral work on insurance,” in which Treasury argues that “the FSB’s activities should be limited to its purpose of monitoring and enhancing global financial stability” and that “the IAIS should take additional action to further increase transparency and stakeholder input into IAIS decision-making,” and urges “U.S. members of the FSB . . . to revise the G-SIFI framework so that it appropriately takes into account the differentiated ways that sectors are structured and manage risks”; (xiii) “advancing American competiveness abroad,” in which Treasury indicates that the Treasury Secretary “will direct FIO and the Undersecretary for International Affairs to enhance engagement in multilateral and bilateral dialogues on issues concerning the insurance sector’s international market access”; (xiv) “insurer investment in infrastructure”; and (xv) “retirement security,” in which Treasury recommends that “the [DOL] and Treasury . . . develop proposals on how to establish or certify one or more expert, independent fiduciary entities to assess the long-term financial strength of annuity providers.”
Office of Financial Research Launches New Monitoring Tools
On 25 October, the Office of Financial Research (“OFR”) Director Richard Berner announced two new OFR tools monitoring financial stability. The two tools are: (i) the Financial System Vulnerability Monitor (“FSVM”), which as Director Berner explained, is “a heat map of 58 indicators of potential vulnerabilities in the U.S. financial system, organized in six categories”; and (ii) the Financial Stress Index (“FSI”), which he explained is “a daily market-based snapshot of stress in global financial markets . . . constructed from 33 financial market variables, such as yield spreads, valuation measures, and interest rates.”
House Financial Services Subcommittee on Housing and Insurance Holds Hearing on the Federal Government’s Role in the Insurance Industry
On 24 October, the U.S. House Committee on Financial Services Subcommittee on Housing and Insurance held a hearing titled “The Federal Government’s Role in the Insurance Industry.” Chairman of the National Association of Mutual Insurance Companies Paul Ehlert, Professor of Law of the University of Minnesota Law School Daniel Schwarcz, President and Chief Executive Officer of Shelter Insurance Companies Rick Means, and Connecticut Insurance Department Commissioner Katharine Wade (on behalf of the National Association of Insurance Commissioners) testified on a number of issues, including: (i) the role of the Federal Insurance Office (“FIO”); (ii) Congress’s involvement in insurance related international treaties; (iii) state-based insurance regulation; and (iv) AIG’s failure during the financial crisis. Generally, both the representatives and witnesses supported the U.S.’s state-based regulatory framework, but differed in their opinion as to the appropriate level of involvement by the Federal government in overseeing the state-based framework. Additionally, the witnesses agreed that the FIO has a role in insurance regulation, but differed in their opinion as to whether the FIO should only be involved in representing the U.S. abroad, or should be involved in the oversight of state insurance regulation as well.
- The Role of the FIO: When questioned by Ranking Member Emanuel Cleaver (D-MO) as to whether the FIO plays “an important role” in insurance regulation, Mr. Means responded that FIO has a role in insurance regulation but that it needs to “stay out of state regulation” and “be the face of the [U.S.] insurance business internationally, . . . getting input from Congress [and] getting input from the states.” When questioned by Rep. Bill Posey (R-FL) as to whether the FIO strengthens the U.S.’s position in international standard-setting discussions, Mr. Ehlert responded no, stating that the FIO has taken positions on capital standards in the past that were “adverse to [U.S.] state regulators,” and arguing that the “lack of coordination and collaboration” between the FIO and state insurance regulators shows that the FIO often acts unilaterally. Mr. Means agreed with Mr. Ehlert’s statements.
- State-Based Insurance Regulation: When questioned by Subcommittee Chairman Sean Duffy (R-WO) as to whether the U.S. should replace its state-based regulatory arrangement with another regulatory model, Mr. Schwarcz responded that the U.S. currently has a “dual system . . . [wherein] the Federal government plays a role . . . that’s appropriate [and] consistent with state primacy.” Mr. Schwarcz later testified, however, that “state insurance regulators are not well equipped” to address issues related to systemic risk because they focus on “individual insurance entities [and] do not focus holistically.”
- Congress’s Involvement in Insurance Related International Treaties: When questioned by Subcommittee Chairman Duffy whether Congress “should have a role in approving or disapproving covered agreements,” Mr. Ehlert responded in the affirmative, stating that Congress would not want “abdicate [its] lawmaking ability . . . to some international regulatory bodies.”
- AIG’s Failure During the Financial Crisis: When questioned by Subcommittee Chairman Duffy as to whether it was the holding company or the insurance business of AIG that failed during the financial crisis, Ms. Wade responded that AIG’s challenges during the financial crisis were a result of the holding company, for which the Office of Thrift Supervision was the consolidated regulator. She added that state insurance regulators “had identified securities lending issues and were winding those down” but that these regulators were “preempted from addressing the issues” that caused AIG’s failure. Mr. Schwarcz later testified that while AIG had major issues with its credit default swaps at the holding company level, the company also had major issues with its securities lending operations that “were not caught in time by the state insurance regulators.”
Senators Elizabeth Warren and Sheldon Whitehouse Send Letters to FSOC Members Raising Concerns Regarding the Decision to Rescind AIG’s Designation as Nonbank SIFI
On 23 October, Sen. Elizabeth Warren (D-MA) and Sen. Sheldon Whitehouse (D-RI) sent co-authored letters to each voting member of the FSOC regarding the Council's decision to rescind AIG's systemically important financial institution (“SIFI”) designation. Specifically, the Senators expressed concerns that: (i) the decision to de-designate AIG as a SIFI “appears to have been made with little substantive justification”; (ii) “the FSOC ignored several of its own key procedural rules” in reaching the decision; and (iii) “additional actions by the FSOC raise questions about the extent to which the Council was working with insurance industry representatives in reaching the decision.” Accordingly, the Senators requested information regarding, among other things: (i) “what protections [the] FSOC [has] in place to ensure that individuals with an interest in pending FSOC decisions do not inappropriately influence or attempt to influence FSOC officials who will be deciding these matters”; (ii) whether any “FSOC official, or the staff of any FSOC official contact the Property Casualty Insurer's Association of America, the U.S. Chamber of Commerce, or any other member of a trade organization or lobbying group representing the insurance industry, with information about the decision to de-designate AIG as a SIFI before FSOC's initial public announcement”; (iii) whether the “FSOC [has] protections in place to prevent leaks of key decisions in advance of official public notice”; (iv) the reasoning behind the “FSOC bypass[ing] its notice and transparency policies that require one week of advanced public notice of any hearing; and (v) the reasoning behind the FSOC‘s decision “that it was not necessary to conduct an independent evaluation of whether AIG met the second standard for SIFI designation.” The Senators requested that the information be provided some time in October 2017.
SEC & SECURITIES
SEC Announces Measures to Facilitate Cross-Border Implementation of MiFID II Research Provisions
On 26 October, the Division of Trading and Markets and the Division of Investment Management, “following consultation with European authorities, and in response to concerns that investors could lose access to valuable research,” issued three no-actions letters, available here, here, and here, designed to, according to the press release, “provide market participants with greater certainty regarding their U.S. regulated activities as they engage in efforts to comply with the . . . [European Union’s Markets in Financial Instruments Directive (“MiFID II”)] in advance of the Jan. 3, 2018, implementation date.” As the press release explains, the no-action letters grant relief, subject to various terms and conditions, that allows: (i) “broker-dealers, on a temporary basis, [to] receive research payments from money managers in hard dollars or from advisory clients' research payment accounts”; (ii) “money managers [to] continue to aggregate orders for mutual funds and other clients”; and (iii) “money managers [to] continue to rely on an existing safe harbor when paying broker-dealers for research and brokerage.” During the temporary relief period, the “staff will monitor and assess the impact of MiFID II's research provisions on the research marketplace and affected participants in order to determine whether more tailored or different action, including rulemaking, is necessary and appropriate in the public interest.”
Senate Committee on Banking, Housing, and Urban Affairs Holds Hearing for Nomination of Hester Peirce and Robert Jackson as SEC Commissioners
On 24 October, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the nomination of Hester Peirce for a Republican Commissioner seat on the SEC and Robert Jackson for a Democratic Commissioner seat on the SEC. The nominees testified on a number of issues, including: (i) their priorities; (ii) the consolidated audit trail (“CAT”); (iii) cybersecurity; (iv) regulatory oversight by FINRA; and (v) the Department of Labor’s (“DOL”) Fiduciary Duty Rule.
- Priorities for the Nominees: When questioned by Committee Chairman Mike Crapo (R-ID) as to what areas the SEC should prioritize in the upcoming year in addition to its current rulemaking agenda, Ms. Peirce listed: (i) oversight of firms through the SEC’s Office of Compliance Inspections and Examinations; (ii) oversight of self-regulatory organizations, such as FINRA; (iii) equity and fixed income market structures; (iv) cybersecurity; and (v) other pressing issues that she becomes aware of through her work at the SEC. Mr. Jackson listed three areas in response: (i) cybersecurity; (ii) the completion of outstanding rules required by the Dodd-Frank Act, such as those related to executive compensation and the “clawback of erroneously awarded pay”; and (iii) enforcement actions, especially with respect to insider trading.
- CAT: When questioned by Sen. Tom Cotton (R-AR) as to whether it was “smart” for the SEC to start collecting information in light of the recent cyber incidents, Ms. Peirce responded that she has cybersecurity concerns whenever the SEC collects data, and that before it does, the SEC should ask whether it needs to collect the data, what the data will be used for, and whether the SEC can protect it, and she is “not convinced that [these] questions have been answered to [her] satisfaction” but that it “is difficult to know that without being at the SEC.” Mr. Jackson responded that the creation of the CAT was “motivated by the flash crash” and the need to prevent similar events, and questioned to what “degree [the SEC] needs personally identifiable information to solve that problem.”
- Cybersecurity: When questioned by Sen. Jack Reed (D-RI) about companies’ disclosure of cyber incidents, Ms. Peirce responded that it is “important for [companies] to think about how to disclose [cybersecurity risks] to investors and for the SEC to think about whether it needs to provide additional guidance to help them do that.” Mr. Jackson agreed, stating that the “risks that companies face on the cybersecurity front today are different than they were a few years ago” and emphasized the need to ensure that rules and disclosures “keep pace with those changes.” When questioned by Sen. Reed as to whether the SEC needs more resources devoted to addressing cybersecurity, Mr. Jackson responded yes, noting that “the markets that the SEC hopes to regulate are spending billions of dollars on the latest technology,” so the SEC needs additional resources to “keep up.” Ms. Peirce emphasized the importance of ensuring that resources are being used effectively, and stated that “it is difficult from the outside to understand how well resources are being used.”
- Oversight of FINRA: When questioned by Sen. Mike Rounds (R-SD) as to whether FINRA’s approach to compliance is “appropriate at this time” and whether its direction and approach needs to be reviewed, Ms. Peirce agreed with the need for review and expressed her concerns regarding transparency at FINRA as well as whether firms are “scared” to report misbehavior to FINRA. Mr. Jackson responded that “it is important that the SEC take a prominent oversight role with respect to FINRA” and expressed his concern about transparency at FINRA as it relates to brokers who engage in fraud.
- Fiduciary Duty Rule: When questioned by Sen. Rounds regarding their views on the DOL’s Fiduciary Duty Rule and what role the SEC should have in the development of fiduciary standards moving forward, Mr. Jackson responded that the “SEC should have an important role in the development of these fiduciary standards,” that “it is a natural area for the SEC to do rulemaking,” and that there needs to be “consistency” with regards to the standards set for different products. Ms. Peirce expressed concerns about the Fiduciary Duty Rule “as it is currently written” and argued that it was important for dialogue between the SEC, DOL, and state regulators about issues related to the Rule.
SEC Commissioner Michael Piwowar Delivers Speech on Market Structure
On 26 October, SEC Commissioner Michael Piwowar delivered remarks before the FINRA and Columbia University Market Structure Conference, addressing issues related to market structure. During his remarks, Commissioner Piwowar: (i) emphasized the need for a “comprehensive review of equity market structure,” including a “comprehensive review of the most fundamental change to our market structure in the past 20 years, Regulation NMS”; (ii) expressed his “hope to vote soon on a transaction fee pilot to test the incentives in our existing exchange pricing models” and that it is his “expectation that this pilot will come in the form of a rulemaking rather than an NMS plan”; and (iii) expressed his openness to continuing the SEC’s Equity Market Structure Advisory Committee (the group’s charter is expiring in January 2018), “to the extent that the EMSAC can continue to provide the Commission with high quality recommendations.”
CFTC & Derivatives
CFTC Issues Order Extending Current Swap Dealer De Minimis Threshold Exception
On 26 October, the CFTC issued an order establishing 31 December 2019 as the new “de minimis threshold phase-in termination date.” Prior to the issuance of the order, the current threshold of $8 billion was scheduled to decrease to $3 billion on 31 December 2018. As explained in the order, the “year’s delay [will] provide additional time for the new Commissioners and the new Director of the Division of Swap Dealer and Intermediary Oversight . . . to better familiarize themselves with the issues relevant to the de minimis exception and results of the swap data analysis currently underway.”
Keynote Remarks of Commissioner Brian Quintenz on Oversight of DCOs
On 17 October, CFTC Commissioner Brian Quintenz delivered the keynote remarks before the Federal Reserve Bank of Chicago's Fourth Annual Conference on CCP Risk Management addressing the CFTC’s oversight of derivatives clearing organizations (“DCOs”). During his speech, Commissioner Quintenz described the CFTC’s three primary methods for overseeing DCOs, namely: (i) “review[ing] DCO applications and rule changes,” (ii) “examin[ing] DCOs for compliance with the statute and regulations,” and (iii) conducting “daily risk surveillance.” Commissioner Quintenz also (i) called for access to Federal Reserve Bank accounts to be “expanded to all DCOs regardless of systemically important designation”; (ii) argued that “clearinghouses . . . diversify [risk] among their membership” and warned that the decreasing number of futures commission merchants (“FCMs”) is restricting the clearing system’s ability to mutualize risk, as well as increasing the interconnectivity of firms’ exposures; and (iii) argued that the “application of the [supplemental leverage ratio] to clearing customer margin reflects a fundamental misunderstanding of central clearing” and that “DCOs, FCMs, clients, and . . . [most] financial regulators uniformly recognize this is having multiple devastating impacts.”
CFTC Issues Report on Clearinghouse Liquidity Stress Test Results
On 16 October, the CFTC issued a report detailing the “results of an evaluation of settlement liquidity at clearinghouses.” Key findings identified by the evaluation include: (i) “all of the clearinghouses demonstrated the ability to generate sufficient liquidity to fulfill settlement obligations during the immediate end-of-day cycle, and in the case of those clearing IRS, during subsequent payment cycles”; (ii) the clearinghouses generated funds in a number of ways, including “using cash received from maturing reverse-repurchase agreements”, “selling collateral,” “accessing cash balances at a commercial bank,” “accessing cash balances at a central bank,” “converting one currency to another,” and “entering into repurchase agreements”; and (iii) “in instances where multiple DCOs used the same methodology or the same firm to raise funds, staff concluded that the cumulative size of liquidity requirements in this scenario would not impair the ability of each clearinghouse to meet its settlement obligations on time.”
Keynote Address of Daniel Gorfine on FinTech and LabCFTC
On 19 October, CFTC Director of LabCFTC and Chief Innovation Officer Daniel Gorfine delivered the keynote address before the 33rd Annual FIA Futures & Options Expo addressing FinTech and the recently launched LabCFTC initiative. Director Gorfine noted that the LabCFTC initiative will be composed of “three core components”: (i) the “Guide Point,” which is the “newly established dedicated point of contact for innovators to meet with the CFTC, learn about our regulatory framework, and obtain feedback”; (ii) the “CFTC 2.0” initiative, which the Commission will use “to explore all tools that permit us to ‘kick the tires’ and truly understand emerging technologies and system”; and (iii) the “DigitalReg” initiative, which “will help the Commission identify and develop regulatory tools, approaches, and culture that promote market-enhancing innovation and satisfy key regulatory objectives.” Additionally, Director Gorfine provided updates on several current FinTech initiatives related to: (i) engagement, noting that the Commission will aggregate and publish, through regular publications and through an annual white paper, lessons it learns from “office hour sessions”; (ii) LabCFTC Primers, announcing the release of its first such primer on the topic of virtual currencies; (iii) regulatory collaboration, noting that the CFTC sees “significant opportunity to formalize our collaboration efforts with international and domestic regulators who are similarly focused on facilitating market-enhancing innovation”; and (iv) the recently reconstituted Technology Advisory Committee, noting that he is excited about how this body will augment the work of LabCFTC.
DOL FIDUCIARY RULE
American Oversight Files Lawsuit Against DOL To Compel Release of Fiduciary Duty Rule Documents
On 24 October, American Oversight, a watchdog organization, filed in the U.S. District Court for the District of Columbia a complaint “seeking declaratory and injunctive relief to compel compliance with the requirements of [Freedom of Information Act (“FOIA”)]” with respect to certain documents related to, among other things, the DOL’s rulemaking process for the Fiduciary Duty Rule. According to the complaint, American Oversight filed a request on 21 July 2017 seeking the release of certain documents, including, among other things, calendar entries, meeting agendas, and materials distributed during meetings relating to the Fiduciary Duty Rule, and has filed its complaint in response to the DOL’s failure to provide the documents requested within the period required under the FOIA.
SEC Chairman Jay Clayton States SEC Must Respect DOL Rulemaking Authority
On 24 October, InvestmentNews reported that SEC Chairman Jay Clayton, speaking at the SIFMA annual conference, stated that the SEC cannot simply take over the rulemaking process of the Fiduciary Duty Rule, because the DOL has its own process separate from that of the SEC. Chairman Clayton expressed the need for cooperation between the parties, stating that the SEC has “the authority and the expertise to be leaders in this space. The DOL has a responsibility. States have a responsibility. We need to cooperate.”
FINRA Chief Legal Officer Robert Colby States FINRA Ready to Provide Technical Assistance on Fiduciary Duty Rule
On 20 October, ThinkAdvisor reported that FINRA Chief Legal Officer Robert Colby, speaking on a panel at the National Society of Compliance Professionals national conference on 16 October 2017, stated that “FINRA stands ready to provide ‘technical assistance’ to the Labor Department and the Securities and Exchange Commission as the two agencies coordinate a fiduciary rulemaking.” Additionally, ThinkAdvisor reported that Mr. Colby stated he “would love to see a best-interest standard applied that was similarly applied across the broker-dealer world.”
UPCOMING EVENTS AND DEADLINES