US Regulatory Update
Core Principles for Regulating the U.S. Financial System
On 3 February, President Donald Trump signed an executive order outlining the Administration’s “Core Principles” for regulating the U.S. financial system and reviewing the regulatory system established by the Dodd-Frank Act. The Core Principles include: (i) empowering Americans to make independent and informed financial decisions, save for retirement, and build wealth; (ii) preventing taxpayer-funded bailouts; (iii) fostering growth and vibrant markets through more rigorous regulatory impact analysis that address systemic risk and market failures; (iv) enabling American companies to be competitive with foreign firms in domestic and foreign markets; (v) advancing American interests in international financial regulatory negotiations; (vi) making regulation more efficient, effective, and tailored; and (vii) restoring public accountability within federal financial regulatory agencies and rationalizing the federal financial regulatory framework. In addition, the executive order directs the Department of Treasury Secretary, in consultation with the Financial Stability Oversight Council's (FSOC) member agencies (which include, among others, the Federal Reserve, the OCC, the SEC, and the CFTC) to report to the president within 120 days and periodically thereafter on the extent to which existing laws and other regulatory obligations promote the Core Principles and what actions are being taken to promote and support the Core Principles.
Department of Treasury Secretary
On 1 February, the Senate Finance Committee favorably reported to the full Senate the nomination of Steven Mnuchin to be the new Treasury Secretary. In Mnuchin’s responses last month to questions submitted by Committee members, Mnuchin argued that the FSOC’s role as a "common forum for key financial regulators to meet, share information and address financial sector industry issues is inherently valuable," but intends to undertake a "comprehensive review of the FSOC's powers and institutional processes," including a review of the "work that has been done on the so-called shadow banks and other non-banks that pose risk to the economy."
Federal Reserve’s Participation in International Fora
On 31 January, House Financial Services Committee Vice Chairman Patrick McHenry (R-NC) sent a letter to Federal Reserve Chair Janet Yellen criticizing the Federal Reserve’s participation in international financial fora, such as the FSB, in light of President Donald Trump’s prioritization of “America’s interest in international negotiations.” Noting that the Administration’s objectives in international negotiations will likely require a comprehensive review of past agreements with respect to insurance, derivatives, systemic risk, and asset management, Vice Chairman McHenry instructed the Federal Reserve to cease all attempts to negotiate binding standards until President Trump has had an opportunity “to nominate and appoint officials that prioritize America’s best interests.”
Reducing Regulation and Controlling Regulatory Costs
On 8 February, the Public Citizen Litigation Group, the National Resources Defense Council, and the Communications Workers of America filed a complaint with the District Court for the District of Columbia arguing that President Donald Trump's executive order on Reducing Regulation and Controlling Regulatory Costs exceeds the president's constitutional authority and directs agencies to engage in arbitrary and capricious actions. The executive order will: (i) require federal agencies to identify what existing regulations can be repealed; (ii) require federal agencies to repeal two rules for every new rule that is proposed and adopted, and (iii) set an annual cap on the cost of new federal regulations to ensure that regulations issued for the rest of the fiscal year, offset by repealed regulations, have a net cost of zero dollars. The complaint claims, among other things, that the executive order: (i) directs agencies to disregard the benefits of new and existing rules, which will force agencies to take regulatory actions that harm Americans; (ii) forces agencies to repeal regulations that they have already approved through notice-and-comment rulemaking, for the sole purpose of eliminating costs that the underlying statutes do not direct be eliminated; (iii) forces agencies to violate the statutes from which the agencies derive their rulemaking authority and the Administrative Procedure Act (APA); and (iv) will slow "to a halt" the implementation of governing statutes due to the new cost assessment requirements of any newly proposed or final rule and at least two existing rules.
Financial CHOICE Act 2.0
In a memo dated 6 February 2017, House Financial Services Committee Chairman Hensarling outlined the amendments he would make to a new version of his Financial CHOICE Act that he introduced last year. Among others, the amendments include establishing an exemption for inter-affiliate margin for internal derivatives transactions and limit prudential regulators from unilaterally frustrating the exemption, and amending the Retail Investor Protection Act to require the Department of Labor (DOL), in promulgating any fiduciary rule, to adhere to SEC standards after the SEC has promulgated its own rule. The amendments also include several “capital market improvements” to the SEC, including (i) imposing term limits on the Investor Advisory committee; (ii) establishing a “Wells Committee 2.0” to reevaluate the enforcement program and prohibiting any rulemaking by enforcement; and (iii) prohibiting co-conspirators from receiving a whistleblower reward.
Authorization and Oversight Plan for the 115th Congress
On 7 February, the House Financial Services Committee approved the Committee’s Authorization and Oversight Plan for the 115th Congress. The plan sets out areas in which the Committee and its subcommittees expect to conduct oversight of Congress, including: (i) to identify cuts to or the elimination of federal programs that are inefficient, duplicative, outdated, or more appropriately administered by State and local government; and (ii) to identify agencies and programs with lapsed authorizations or permanent authorizations that have not been subject to a comprehensive review in the prior three Congresses.
SEC & SECURITIES
OCIE Examination of Investment Advisers
On 7 February, the SEC’s Division of Inspections and Examinations (OCIE) issued arisk alert listing the five most frequent compliance topics identified in OCIE examinations of investment advisers. The five topics address: (i) compliance policies and procedures; (ii) regulatory filings; (iii) the custody rule; (iv) the code of ethics; and (v) books and records.
- Compliance Policies and Procedures: OCIE found deficiencies related to compliance policies and procedures including: (i) compliance manuals not being reasonably tailored to the adviser’s business practices; (ii) annual reviews not being performed or not addressing the adequacy of the adviser’s policies and procedures; (iii) advisers not following policies and procedures; and (iv) compliance manuals being out of date.
- Regulatory Filings: OCIE found deficiencies with respect to regulatory filings including: (i) inaccurate disclosures; (ii) untimely amendments to Forms ADV; (iii) incorrect and untimely filings of Forms PF; and (iv) incorrect and untimely filings of Forms D.
- Custody Rule: OCIE found deficiencies related to the custody rule including: (i) advisers not recognizing that they may have custody due to online access to client accounts; (ii) advisers with custody failing to provide independent public accountants with sufficient information during surprise examinations; and (iii) advisers not recognizing that they may have custody as a result of certain authority over client accounts.
- Code of Ethics: OCIE found deficiencies related to codes of ethics including: (i) not identifying access persons of the adviser; (ii) missing required information; (iii) untimely submission of personal trading transactions and holdings; and (iv) not providing a description of the code of ethics in Forms ADV.
- Books and Records: OCIE found deficiencies related to books and records including: (i) advisers not maintaining all required records; (ii) books and records being inaccurate or not up to date; and (iii) inconsistent recordkeeping.
Pay Ratio Disclosure Rule
On 6 February, Acting Chairman Piwowar issued a statement calling the SEC staff to reconsider the implementation of the pay ratio disclosure rule and considering additional guidance or relief. The rule was adopted in August 2015 and requires a public company to disclose: (i) the median of the annual total compensation of all its employees, except that of the CEO; (ii) the annual total compensation of its CEO; and (iii) the ratio of those two amounts. Currently, companies are required to report the pay ratio disclosure for the first fiscal year beginning on or after January 1, 2017, which would result in disclosure in 2018. Piwowar also requested public comments, with the comment period ending on 23 March 2017.
Conflict Mineral Rule
On 31 January, Acting Chairman Piwowar issued a statement indicating that he has directed the SEC staff to reconsider whether the SEC 2014 guidance on the conflict mineral rule is still appropriate and whether any additional relief is appropriate in the interim. Piwowar also requested public comments, with the comment period ending on 17 March 2017.
On 7 February, it was reported that staff at the SEC had recommended an enforcement action against the New York Stock Exchange (NYSE) for a nearly four-hour long trading halt on 8 July 2015. The results of the notice from the SEC and any enforcement action related to the outage are unknown at this time, but the NYSE indicated that it has sent the SEC a letter defending its actions before and during the trading outage, stating that it was “a technology outage [and] it was very unfortunate… but we don’t believe that it actually violated any law.”
On 13 February, the CFTC Division of Swap Dealer and Intermediary Oversightissued no-action relief to swap dealers (SDs) for failure to comply with the variation margin requirements for swaps that are subject to a 1 March 2017 compliance date. Under CFTC rules, SDs must collect and post initial and variation margin with each counterparty that is a SD, major swap participant (MSP), or financial end user. Noting that the 1 March 2017 compliance deadline could have significant impact on the ability of pension funds, asset managers, and insurance companies to hedge positions, the Division indicated that it would extend no-action relief to 1 September 2017, subject to certain additional requirements.
Swap Dealers Conducting Business in EU
On 1 February, the CFTC’s Division of Swap Dealer and Intermediary Oversightissued no-action relief to SDs that conduct business in the EU. The CFTC adopted rules setting margin requirements for uncleared swaps as well as a cross-border margin rule which sets out circumstances in which a covered swap entity complying with comparable foreign margin requirements does not have to satisfy the CFTC margin requirements. In November 2016, the European Commission requested that the CFTC determine that the margin regulatory technical standards under the European Market Infrastructure Regulation (EMIR RTS) is comparable to the CFTC’s margin rule, but the CFTC has yet to make such a determination. The EMIR RTS became effective on 4 January 2017, requiring certain covered swap entities to comply with both the CFTC margin rule and the EMIR RTS by 4 February 2017. In light of the conflicting requirements, the Division indicated that it would issue no-action relief until 8 May 2017 while the CFTC undertakes its comparability analysis.
CFTC & DERIVATIVES
Potential CFTC Chairman
On 8 February, it was reported that the Trump Administration is preparing to nominate CFTC Acting Chairman Christopher Giancarlo as the next Chairman of the CFTC. Gary Cohn, President Donald Trump’s senior economic adviser, also indicated that Acting Chairman Giancarlo is likely to be President Trump’s nominee for the position, as few other individuals have been seriously considered for the role. If appointed, Acting Chairman Giancarlo is expected to adopt a more industry-friendly approach to regulating the derivatives market and could ease the Commission’s swap-trading requirements.
Variation Margin Deadline for Non-Cleared Derivatives
On 31 January, the International Swaps and Derivatives Association (ISDA) CEO Scott O’Malia issued a statement warning regulators that dealers and their clients might not have sufficient time to the meet the 1 March 2017 variation margin deadline for non-cleared derivatives. O’Malia indicated that firms were experiencing difficulties in meeting the deadline because the new rules set strict requirements on all aspects of non-cleared derivatives transactions, which require manual intervention, analysis, and discussion between dealers and each counterparty. O’Malia noted that Hong Kong, Singapore, and Australia had recently adopted extensions of the 1 March deadline and urged other regulators to give the market extra time to comply with the requirements.
Disclosure of Aggregation Exemptions from Position Limits
On 6 February, the CFTC’s Division of Market Oversight issued no-action relief to certain market participants, who are eligible for an exemption from aggregation of position limits, from having to comply with notice filling and certification requirements that are scheduled to become effective on 14 February 2017. Under CFTC rules, certain market participants relying on exemptive relief are required to file notice with the CFTC demonstrating compliance with the conditions applicable with the claimed exemption. The Division acknowledged that there was insufficient time for market participants to prepare the new notice filings and certifications. The no-action relief expires 14 August 2017. The CFTC alsointroduced a new portal that will provide the form and manner for filling aggregate exemption notices, which will be available starting 11 February 2017.
Disruptive Elements of Regulatory Activity
On 13 February, CFTC Commissioner Bowen delivered a speech identifying “four disruptive elements” that she believes have been responsible for recent regulator activity:
- Technology: Commissioner Bowen identified technology and cybersecurity as key market place disruptors. She expressed optimism that the CFTC will complete its work on Regulation AT and noted that it has already adopted cybersecurity safeguard requirements for futures and swaps market participants. She also urged regulators to “watch for ways to encourage technology while also supporting the people displaced by it.”
- Demographics: Commissioner Bowen urged regulators to respond to the increased change in demographics and encouraged companies, non-profits, and the government to increase diversity to ensure that “all good argument are serious considered.”
- Economics: Noting that Western economies may have structural issues, she urged regulators to be “mindful how the overall economy is functioning and what effect market regulations are having on the economy.” She highlighted position limits rulemaking as a “critical step to improving the functioning and fairness of our economy.”
- Institutions: Commissioner Bowen stated that the U.S. is experiencing a loss of trust between the public and the market, the government, and financial institutions. In order to increase this trust, she said the CFTC must be more aggressive in enforcing rules fairly, “including being willing to take individuals and institutions to court rather than just settle with them.”
NIST Cybersecurity Standards
On 10 January, the National Institute of Standards and Technology (NIST)proposed updating its cybersecurity standards and practices blueprint for organizations and businesses. The draft updated framework includes new provisions for assessing cybersecurity risk posed by third-party vendors, as well as a new section on measuring the cost-effectiveness of cybersecurity programs. The comment period closes on 10 April 2017 and NIST plans to convene a public workshop in May 2017 to discuss proposed changes to the framework. The NIST intends to release a final framework in the Fall of 2017.
DOL FIDUCIARY RULE
On 3 February, President Trump issued a memorandum directing the DOL to re-examine its final fiduciary rule to determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice. As part of the re-examination, the memorandum instructed the DOL to prepare an updated economic and legal analysis of the fiduciary rule that considers, among other things, whether: (i) the rule has harmed or is likely to harm investors due to a reduction of access to investment advice, information, and products; (ii) the rule has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees; and (iii) the rule is likely to result in increase in litigation or prices for retirement services for investors and retirees. In addition, depending on the findings of the re-examination, the order directs the DOL to publish for notice and comment a proposal rescinding or revising the rule.
- In response to the memorandum, it was reported on 9 February that the DOL sent two documents to the Office of Management and Budget for approval. The first document includes a proposed rulemaking that would delay the rule’s 10 April 2017 effective date by 180 days, with a comment period of 15 days. The second document seeks to initiate another round of public comments for the rule, but does not indicate how long the comment period would be.
- On 7 February, Rep. Elizabeth Warren (D-MA) sent a letter to Acting Secretary of Labor Edward Hughes urging him not to delay the 10 April 2017 effective date of the fiduciary rule. Senator Warren asserted that a decision to rescind or delay the implementation of the rule would “rip billions of dollars in retirement savings from the pockets of hardworking Americans and put it straight into the hands of giant financial institutions.” Senator Warren indicated that she had received letters from 21 financial companies that supported the implementation of the rule.
On 8 February, Chief Judge Barbara Lynn of the United States District Court for the Northern District of Texas granted summary judgment in favor of the DOL in the lawsuit brought by a group of nine financial industry trade groups. Chief Judge Lynn held that the DOL did not exceed its authority in promulgating the rule, which requires financial advisers to act in the best interests of their clients in retirement accounts. In addition, she held that the creation of the best-interest contract exemption, a legally binding contract with clients that allows advisers to charge commissions or take third-party payments, did not exceed the DOL’s statutory authority to grant conditional exemptions, noting that conditions of the exemption are “reasonable” and have been deemed workable by the industry.
- Prior to granting summary judgment in favor of the DOL, Chief Judge Lynn denied a motion filed by the Department of Justice (DOJ) asking her to stay proceedings in the lawsuit pending a “status report” the DOJ planned to file on or around 10 March 2017 in response to President Trump’s 3 February 2017 memorandum directing the DOL to review the rule.
- In response to the decision, the financial industry trade groups stated that they “continue to believe that the DOL exceeded its authority, and will pursue all of [their] available options to see that this rule is rescinded.”
UPCOMING EVENTS AND DEADLINES
o 16 February: House Financial Services Committee Housing and Insurance Subcommittee hearing on the U.S.-EU covered agreement.
o 28 February: comments due on CFTC re-proposal on position limits for derivatives.
o 9 March: SEC Investor Advisory Committee Meeting.
o 16 March: comments due on CFTC proposal on capital requirements of swap dealers and major swap participants.