US Regulatory Update
Treasury Secretary Mnuchin and OMB Director Mulvaney Joint Statement on Budget Results for FY18
On 15 October, Department of the Treasury (“Treasury”) Secretary Steven Mnuchin and Office of Management and Budget (“OMB”) Director Mick Mulvaney released a joint statement on the budget results for FY18. The statement reported that the U.S. deficit increased to $779 billion, $113 billion higher than the deficit in FY17. As a percentage of GDP, the deficit was 3.9 percent, an increase from 3.5 percent in FY17 and above the average of 3.2 percent over the last forty years. Federal receipts rose by $14 billion, an increase of 0.4 percent, and outlays increased by $127 billion.
FSOC Holds Meeting
On 16 October, the Financial Stability Oversight Council (“FSOC”) held an executive and open session. At the meeting, the FSOC announced that it had unanimously voted to remove the “systemically important financial institution” designation from Prudential Financial, Inc. Treasury Secretary Mnuchin said that the decision “follows extensive engagement with the company and a detailed analysis showing that there is not a significant risk that the company could pose a threat to financial stability.” The FSOC also discussed (i) its 2018 annual report, (ii) Brexit and the steps regulators are taking to identify and address potential changes that could affect the U.S. financial markets or institutions, and (iii) alternative reference rates. The FSOC also approved the minutes from its 12 September 2018 meeting. The minutes include the FSOC’s discussion of, among other things, (i) its 2018 annual report, (ii) its fiscal year 2019 budget, and (iii) an update on the annual reevaluation of the designation of a nonbank financial company.
OMB Releases Semiannual Unified Rulemaking Agenda
On 17 October, the OMB’s Office of Information and Regulatory Affairs issued its Fall 2018 Unified Agenda of Regulatory and Deregulatory Actions (“Agenda”), which is intended to “[demonstrate] this Administration’s ongoing commitment to fundamental regulatory reform and a reorientation toward reducing unnecessary regulation burdens on the American people.” The Agenda includes input from various regulators of the financial services industry. For example: (i) the Bureau of Consumer Financial Protection announced that it intends to reconsider the Payday, Vehicle Title, and Certain High-Cost Installment Loans rule before the scheduled compliance date of August 2019; and (ii) the Securities and Exchange Commission (“SEC”) said it plans to act on the harmonization of its rules for exempt offerings. The Agenda also contains updates from the Federal Reserve (“Fed”), Treasury, Federal Deposit Insurance Corporation (“FDIC”), Commodity Futures Trading Commission (“CFTC”), and Department of Labor.
House Financial Services Committee Members Send Letter Regarding Volcker Rule Modifications
On 16 October, three Republicans on the U.S. House Financial Services Committee, including Committee Chairman Jeb Hensarling, sent a letter to the Treasury, Fed, SEC, Office of the Comptroller of the Currency (“OCC”), FDIC, and CFTC about those agencies’ joint proposal to modify the Volcker Rule. The letter’s principal point is that the proposed rule does not go far enough in reducing the Volcker Rule’s unnecessary complexities, including, for example, the “covered funds” provisions.
SEC & Securities
SEC Director of OMS Delivers Remarks on the Importance of Adequate Disclosures in Municipal Securities
On 10 October, Director Rebecca Olsen of the SEC’s Office of Municipal Securities (“OMS”) delivered remarks before the Municipal Finance Leadership Conference. In her speech, Olsen discussed the importance of adequate disclosures for retail investors in the municipal securities market. She said that it is “essential” for market participants and regulators to ensure that investors are provided with “clear and understandable” information about the issuers of municipal securities. She also outlined, among other things: (i) the role of the SEC OMS; (ii) the importance of accessibility and clarity of information for retail investors; (iii) the regulatory framework governing disclosure requirements; and (iv) the importance of the municipal securities market for retail investors.
SEC Commissioner Jackson Speaks on Competition
On 11 October, SEC Commissioner Robert Jackson delivered remarks before the Open Markets Institute and Village Capital in a speech entitled “Competition: The Forgotten Fourth Pillar of the Sec’s Mission.” In his speech, Jackson claims that the SEC has forgotten part of its original purpose: ensuring securities markets are competitive enough to benefit investors. He provided three examples of areas lacking competition: (i) the concentration of ownership of the thirteen public stock exchanges in the U.S., with twelve of them being owned by just three corporations; (ii) the price investment bankers charge small companies to go public; and (iii) the lack of competition among the U.S.’ credit agencies. Jackson called for the SEC to “bring competition economics back to the SEC,” and called for the creation of an office to focus on competition economics.
SEC No-Action Letter on CCO Quarterly Reports
On 12 October, the SEC’s Division of Investment Management (“IM”) issued a no-action letter that said mutual fund boards can rely on written quarterly chief compliance officer (“CCO”) reports affirming that transactions relating to affiliated underwriting, cross-trades, and affiliated brokerage comply with Investment Company Act Rules 10f-3 (exemption for the acquisition of securities during the existence of an underwriting or selling syndicate), 17a-7 (exemption of certain purchase or sale transactions between an investment company and certain affiliated persons), and 17e-1 (brokerage transactions on a securities exchange). According to the no-action letter requested by the Independent Directors Council, reliance on the CCO’s written quarterly reports “is consistent with the commission’s approach in adopting Rue 38a-1 and would allow boards to avoid duplicating certain functions commonly performed by, or under the supervision of, the CCO.”
Market Data Fees
On 16 October, the SEC unanimously ruled, for the first time, that a pair of requests from the NYSE Arca, Inc. and Nasdaq Stock Market LLC to raise market data fees were not justified. In the SEC’s narrow ruling, exchanges will be allowed to exact data fee increases only if they can demonstrate that the fees for market data are (i) “constrained by significant competitive forces” or (ii) related to the exchange’s cost. Following the ruling, the SEC remanded the challenges to the fee increases. The SEC’s decision sided with the Securities Industry and Financial Markets Association (“SIFMA”), who accused the exchanges of “exploiting their monopoly over market data.”
In a separate order, the SEC remanded over 400 other market-data fee increases that were challenged by SIFMA. The SEC did not reject the price increases, but told the exchanges to review the brokers’ complaints that the fee increases undermine competition. The SEC is allowing the exchanges a year to complete their efforts.
On 16 October, SEC Chairman Jay Clayton released a public statement regarding the SEC’s two orders on market data fees. Chairman Clayton said the SIFMA decision “does not mean the fees were too high, rather it means that the exchanges have not provided sufficient factual and legal support to continue to charge those fees.” Clayton also said that these decisions “will enable the Commission and market participants to more efficiently and effectively ensure that market data fees are set, reviewed and regulated in the best interest of our markets and our Main Street investors” and “taken together with other initiatives…will improve [the SEC’s] regulation of market structure as it exists today and will inevitably continue to evolve.”
On 16 October, SEC Commissioners Hester Peirce and Elad Roisman released a joint public statement regarding the SEC’s two orders on market data fees. The Commissioners issued the joint statement to (i) “explain [their] rationale and note the limited precedential effect of this holding”; (ii) “indicate the type of analysis [they] would find useful in determining whether a fee filed for an exchange’s non-core product or service is fair and reasonable; and (iii) “raise a critical policy question underlying these proceedings as well as the pending challenges to other exchange fees.” The Commissioners also raised concerns over the Order Protection Rule, which they believe “motivates demand for these and other proprietary market data products and may make it more difficult for firms to exert market pressure on exchanges by diverting order flow elsewhere.” As a result, they ask the Commission to do a “retrospective review” of the Order Protection Rule and consider, “Why do we still have the Order Protection Rule? Who are we protecting? From what? And would other rules or market dynamics serve to protect these interests in a more efficient, and less costly, manner?”
SEC Releases Investigative Report on Cyber Threats
On 16 October, the SEC issued an investigative report cautioning that public companies should consider cyber threats when implementing internal accounting controls. The SEC warned that while cyber threats are relatively new, public companies should always be reviewing and updating their internal accounting controls to address such threats. The SEC’s investigation focused on “business email compromises,” where “perpetrators posed as company executives or vendors and used emails to dupe company personnel into sending large sums to bank accounts controlled by the perpetrators.” The report outlined nine companies that fell victim to this type of cyber fraud. The SEC said it is not pursuing enforcement actions in these matters, but it advised public companies and market participants to ensure that their systems of internal accounting controls address cyber-related threats.
SEC Commissioner Stein Speaks on Retirement Security
On 16 October, SEC Commissioner Kara Stein delivered remarks before the Brookings Institution in a speech entitled “The New American Dream: Retirement Security.” In her speech, Commissioner Stein warned of a “rapidly approaching” retirement crisis and suggested ways the SEC and investors can act to ensure that Americans approaching retirement have adequate savings. Stein believes that the retirement crisis is forming around the depleting Social Security trust fund and the declining availability of employer-sponsored pensions. To mitigate the crisis, Stein called for, among other things: (i) educational investment programs; (ii) continuing incentives for saving; (iii) the SEC’s pursuit of enforcement actions against bad actors; (iv) actions ensuring a “fair and efficient” market; and (v) the creation of a Presidential Working Group on Retirement Security to “enhance the state of retirement security in the United States by making recommendations regarding legislative, regulatory, or other changes.”
SEC Director of IM Dalia Blass Delivers Remarks on Regulation of Mutual Funds
On 16 October, Dalia Blass, the SEC’s Director of IM, delivered remarks before the IDC – 2018 Fund Directors Conference. Blass described the guiding principles for the SEC’s initiatives for and approach to the regulation of mutual fund boards, which include: (i) “improving the retail investor experience”; (ii) “modernizing [the SEC’s] regulatory framework and engagement”; and (iii) “leveraging [the SEC’s] resources efficiently.” Blass also explained the SEC’s decision-making process when it considers mutual fund board responsibilities. That process takes into consideration: (i) whether “a given regulatory action requires board engagement, and the policy goals of any such involvement”; (ii) “[w]hen the staff recommends board involvement, whether it is necessary to require specific board action”; (iii) whether “the board responsibilities prescribed [are] consistent with the board's oversight and policy role”; and (iv) whether “the board responsibilities are clear, up-to-date, and consistent with other regulatory requirements.”
SEC Updates C&DIs Regarding Cross-Border Securities Offering Exemptions
On 17 October, the SEC updated Compliance and Disclosure Interpretations (“C&DIs”) related to certain cross-border securities offering exemptions. The topics covered in the updated C&DIs include: (i) the calculation of U.S. ownership of the subject company; (ii) determination of the subject class; (iii) the “equal treatment” requirements in a tender or exchange offer; (iv) the filing, publication, and dissemination of offer materials; and (v) withdrawal rights.
CFTC & Derivatives
CFTC Commissioner Quintenz Delivers Remarks on Blockchain
On 16 October, CFTC Commissioners Brian Quintenz delivered remarks before the 38th Annual GITEX Technology Week Conference. In his speech, Commissioner Quintenz described some of the regulatory challenges that blockchain “smart contracts” pose. Specifically, he discussed what party should be held responsible when a smart contract violates CFTC rules. He argued that prosecuting the individual users may be an “unsatisfactory, ineffective course of action,” and instead suggested that enforcement actions against the developers of the smart contract code may be appropriate if the code developers, at the time they wrote the code, could reasonably foresee that the code would be used to violate CFTC regulations. Quintenz acknowledged that it will be difficult to enforce CFTC regulations on U.S. smart contract activity because the contracts can be executed easily across borders between foreign counter-parties. As a result, he encouraged developers to work with the CFTC to understand whether a smart contract complies with CFTC regulations, because in the absence of such cooperation from developers, enforcement is the CFTC’s only option.
CFTC Commissioner Behnam Speaks on the Effects of the Financial Crisis
On 16 October, CFTC Commissioner Rostin Behnam delivered remarks before the Federal Reserve Bank of Chicago’s Fifth Annual Conference on CCP [Central Counterparty] Risk Management in a speech entitled “A Decade After the Financial Crisis: Remaining Challenges and New Approaches for the Next Ten Years and Beyond.” In his speech, Commissioner Behnam discussed the challenges for CCPs and swap market participants following the G-20 reforms and the passage of Dodd-Frank regarding, including these areas of concern: (i) futures commission merchant concentration and access to clearing; (ii) the European Commission’s proposed cross-border legislation to make EU authorities the primary supervisors of “systemically risky” U.S. CCPs; (iii) CCP governance and risk management between domestic and international regulators; and (iv) the use of distributed ledger technologies for clearing and settlement.
CFTC Chairman Christopher Giancarlo Speaks on Recent CFTC Developments
On 17 October, CFTC Chairman Christopher Giancarlo delivered remarks before the FIA Expo in a speech entitled “A Week in the Life of the CFTC.” Giancarlo pointed out that the fiscal year that ran from October 2017 through September 2018 “was one of the most vigorous periods of enforcement activity in the history of the agency” because it is the duty of government and particularly the CFTC “to enforce market regulation and prosecute bad actors.” Addressing the EU’s recent proposed cross-border legislation that is, in his view, conflicting and overly burdensome, Giancarlo warned that if the EU imposes such legislation, then “the CFTC will have no choice but to consider a range of readily available steps to protect U.S. markets and market participants.” Giancarlo said that “[o]ther effective options are available in conjunction with fellow U.S. regulatory agencies" and that "the CFTC will not allow U.S. market participants to be put in the completely untenable position of having to choose between violating domestic laws and regulations or violating foreign laws and regulations." Finally, regarding proposed Regulation Automated Trading (“Reg AT”), Giancarlo reiterated his opposition to the proposed regulation because he does not believe the CFTC has the resources to implement Reg AT, and even if the CFTC did, he does not believe Reg AT will be effective in achieving its stated goals.
CFTC Staff Issues Updated Report Assessing Agricultural Block Trades
On 18 October, the CFTC’s Market Intelligence Branch issued a report entitled “Updated Report: Agricultural Black Trade Analysis,” which updates findings from a July 2018 report that analyzed agricultural block trading in the grains, oilseeds, and livestock markets at the Chicago Mercantile Exchange (“CME”). The new report’s updated findings include: (i) “[b]lock trades in the agricultural markets are a very small portion of the overall volume, but are somewhat more significant on specific dates and for certain contract months”; (ii) “[b]lock trades are primarily occurring in nearby months”; (iii) “[m]arket makers appear to be offsetting much of the block volume into the central limit order book”; and (iv) “[t]he prices of all bock trades reviewed appear to be priced within the CME rule for ‘fair and reasonable’ prices.”
On 19 October, the CFTC announced that it will hold an Open Meeting on 5 November to consider: (i) a final rule on amending the De Minimis exception to the swap dealer definition; (ii) a proposed rule on amendments to regulations on swap execution facilities and the trade execution requirement; and (iii) a request for comment regarding the practice of “Post-Trade Name Give-Up” on swap execution facilities.
Treasury Releases Treasury International Capital Data for August 2018
On 16 October, the Treasury released its Treasury International Capital (“TIC”) data for August 2018. In August, all net foreign acquisitions of long-term securities, short-term U.S. securities, and banking flows was a net TIC inflow of $108.2 billion, of which net foreign private inflows were $104.6 billion and net foreign official inflows were $3.6 billion. U.S. residents decreased their holdings of long-term foreign securities, with net sales of $54.7 billion, and foreign residents decreased their holdings of U.S. Treasury bills by $7.8 billion.
Treasury Releases Report on Macroeconomic and Foreign Exchange Polices
On 17 October, the Treasury announced that it had delivered to Congress Treasury’s semiannual Report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States. In the report, the Treasury noted that while China’s exchange rate practices continue to lack transparency, direct intervention by the People’s Bank of China has been limited this year. However, six major U.S. trading partners -- China, Germany, India, Japan, Korea, and Switzerland -- were placed on the “Monitoring List” of major trading partners that merit close attention to their currency practices. The report also said that the U.S. trade deficit “has continued to widen in 2018, partly reflecting robust domestic demand growth in the United States compared to major trading partners, but also due to persistent trade and investment barriers in many economies.”
Treasury Releases Proposed Regulations on Opportunity Zones
On 19 October, the Treasury issued proposed guidance regarding the new Opportunity Zone tax incentive designed to incentivize investment in American communities. The proposed guidance clarifies what gains qualify for deferral, which taxpayers and investments are eligible, and the parameters for Opportunity Funds. According to the Treasury’s press release, “The Opportunity Zone incentive offers capital gains tax relief to investors for new investment in designated areas. Investment benefits include deferral of tax on prior gains as late as 2026 if the amount of the gain is invested in an Opportunity Fund. The benefits also include tax forgiveness on gains on that investment if the investor holds the investment for at least 10 years.” Comments are due 60 days after the proposed guidance is published in the Federal Register.
Fed Releases Minutes from September FOMC Meeting
On 17 October, the Fed’s Federal Open Market Committee (“FOMC”) released the minutes from its 25-26 September meeting. The minutes show that the Fed believes that continuing to gradually increase interest rates is the best formula for preserving a steady economy. Specifically, the minutes read, “With regard to the outlook for monetary policy beyond this meeting, participants generally anticipated that further gradual increases in the target range for the federal funds rate would most likely be consistent with a sustained economic expansion, strong labor market conditions, and inflation near 2 percent over the medium term.” FOMC also said that there may be a period where the Fed will need to go beyond normalization of rates and into a more restrictive stance because that would control inflation from overshooting the Fed’s target and address “the risk posed by significant financial imbalances.”
Fed Vice Chairman Quarles Speaks on Monetary Policy
On 18 October, Fed Vice Chairman Randal Quarles delivered remarks before the Economic Club of New York Luncheon in a speech entitled “Don’t Chase the Needles: An Optimistic Assessment of the Economic Outlook and Monetary Policy.” In his speech, Quarles said that a tick up in the economy’s potential growth rate could warrant a slower pace of rate hikes. Addressing inflation, Quarles said, “There is enough reason to think that the productive capacity of our economy might be increasing so that we should not feel compelled to accelerate our pace. I also think there is enough doubt about current inflation as an infallibly reliable measure of current resource constraints that the continued gradual removal of accommodation is appropriate.” He noted that the more potential growth increases, “the more gradual we can be in our removal of monetary policy accommodation.” He added that “assessment of the pace of potential growth will be important input into what I view as the appropriate path of policy” to achieve the Fed’s “objectives of maximum sustainable employment and price stability.”
· Oct. 22-26: CFTC’s Office of International Affairs to host its 26th annual symposium.
· Oct. 24: FDIC Advisory Committee on Economic Inclusion will hold a meeting to discuss the 2017 FDIC Household Survey data results, review of UK-Financial Conduct Authority mobile study, and youth employment programs and deposit accounts.
· Oct. 25-26: SEC to host a Roundtable on Market Data and Market Access.
· Oct. 26: Comments due on FDIC proposed rule regarding reciprocal and brokered deposits.
· Oct. 29: Comments due on a CFTC proposed rule regarding the registration and compliance requirements for commodity pool operators and commodity trading advisors.
· Oct. 29: Comments due on the SEC’s proposed amendments to the single issuer exemption for broker-dealers.