US Regulatory Update
FTC Holds Hearing on “Common Ownership” Investments
On 6 December, the Federal Trade Commission (“FTC”) held a hearing entitled “Corporate Governance, Institutional Investors, and Common Ownership,” which was presided over by FTC Commissioners Noah Phillips and Rohit Chopra and featured testimony by Securities and Exchange Commission (“SEC”) Commissioner Robert Jackson. At the hearing, the FTC explored two possible theories of competitive harm: (i) do passive index funds that invest across an industry structurally disincentivize target firms from competing and (ii) do such investments foster anticompetitive collusion? One panel was composed of corporate governance experts and investment industry professionals from BlackRock, Vanguard, and State Street, a large union pension fund, and investor/industry trade associations. That panel made several overarching points, including: (i) index funds have become a driving force for retail investors, and (ii) a prohibition of institutional investors from investing in a diversified portfolio of companies would be a “death knell” to such funds. In his testimony, SEC Commissioner Jackson urged regulators to foster greater transparency in the proxy voting process by institutional investors. Jackson said that “we are at a crucial moment in financial history, with corporate elections now being decided by only a handful of index fund managers.” Jackson criticized the SEC’s rules for leaving investors “in the dark” about how institutional investors are voting on issues that “underlie American families’ savings.” Further, Jackson questioned whether index funds may be pursing their own interests as opposed to the interests of their investors. Jackson stated that “a few large institutions today vote millions of American families’ money in corporate elections, all of which has a substantial impact on our economic future.” As a result, he recommended that the SEC “pursue rules that will take advantage of existing data on institutional voting to empower investors with better information as to how their shares are voted in the elections that will determine the future of American capitalism.”
GAO Releases Report on Global Systemically Important Bank Holding Companies
On 10 December, the Government Accountability Office (“GAO”) released a report reviewing controls and “actions to mitigate financial and legal obstacles” to the orderly resolution of global systemically important bank holding companies (“GSIBs”) under the U.S. Bankruptcy Code. Specifically, the report (i) “describes actions GSIBs took to mitigate such obstacles” and (ii) “analyzes expert views on the effectiveness of the actions, need for additional actions, and likely success of an SPOE [single point-of-entry] strategy.” The report found, among other things, that: (i) “[m]ost experts viewed GSIB controls to mitigate financial obstacles as potentially somewhat effective”; (ii) “[e]xperts had mixed views on the potential effectiveness of GSIB controls to mitigate creditor challenges and other legal obstacles but supported certain [U.S. Bankruptcy Code] amendments to further mitigate the obstacles”; and (iii) “[m]ost experts said a GSIB likely could execute its SPOE strategy successfully if its failure affected only itself,” but viewed success as “unlikely if the failure occurred during a widespread market disruption.”
Four Senate Banking Committee Republicans Send Letter to Treasury Secretary Mnuchin
On 10 December, Senators Thom Tillis (R-NC), Mike Rounds (R-SD), Tom Cotton (R-AR), and David Perdue (R-GA), each a member of the U.S. Senate Committee on Banking, Housing, and Urban Affairs (“Senate Banking Committee”), sent a letter to Department of the Treasury (“Treasury”) Secretary Steven Mnuchin “to request an update on the progress being made by the Financial Stability Oversight Council (FSOC) to reform the systemically important designation process for nonbank financial companies.” The Senators said they “agree that Congress should make statutory changes.” but “in the interim [they] believe meaningful reforms can and should be made administratively.” As a result, they strongly encouraged Secretary Mnuchin and his fellow FSOC members “to implement reforms that enshrine due process for market participants and acknowledge business models of individual firms.”
Senate Banking Committee Hearing on the Oversight of the SEC
On 11 December, the Senate Banking Committee held a hearing entitled “Oversight of the U.S. Securities and Exchange Commission.” Testifying at the hearing was SEC Chairman Jay Clayton. In his opening statement, Committee Chairman Mike Crapo (R-ID) expressed his concern about the “misuse” of proxy voting to prioritize environmental, social, and governance (“ESG”) issues over the economic interests of investors. Crapo encouraged Chairman Clayton to take an “aggressive” approach in addressing proxy issues. In response to questions from Crapo and Senator Patrick Toomey (R-PA) regarding proxy voting, Clayton identified three issues the SEC will focus on: (i) proxy plumbing, saying that the verification process does not “work as well as it should”, (ii) shareholder voting, and (iii) proxy advisors. Regarding proxy advisors, Clayton noted that there is “broad agreement” among industry participants that parts of the proxy advisory system can be improved “fairly quickly” and that the SEC will continue to look at the regulation of proxy advisors. Senator Elizabeth Warren (D-MA) asked about Regulation Best Interest and specifically why broker-dealers and investment advisors are subject to different standards. Clayton replied that the “baseline” investment advisor standard is that advisors cannot put their interests ahead of those of their clients, but investment advisors can “cut back” that standard with “informed consent.” The standard for a broker-dealer will be a “fundamental duty” not to put their own interests ahead of their clients. Next, Warren asked why the SEC does not use the same words for both standards, to which Clayton replied that “we may do that.” Regarding the Consolidated Audit Trail (“CAT”), Clayton said that the CAT’s development and implementation is “significantly behind deadlines” and that the first phase will not be implemented until 16 months after its initial deadline. Further, Clayton stressed that the SEC and the CAT processor recognize the importance of handling personally identifiable information (“PII”) properly and that the SEC will not retrieve any PII from the CAT unless it is “absolutely necessary.”
House Financial Services Subcommittee Hearing on International Financial Institutions
On 12 December, the U.S. House Committee on Financial Services’ Subcommittee on Monetary Policy and Trade held a hearing entitled “Evaluating the Effectiveness of International Financial Institutions.” Testifying at the hearing was David Malpass, Under Secretary for International Affairs at the Treasury. Regarding Brexit, Under Secretary Malpass reported that as “Brexit approaches, Treasury is analyzing risks to the international financial system and working with the EU and the UK to ensure continued market access for U.S. firms, including financial services firms, and to avoid cliff-edge risks.” When asked about the International Monetary Fund’s (“IMF”) relationship with Pakistan, Malpass said, “We are working and making clear within the IMF that if it were going to supply any funding to Pakistan, it would not be used to repay Chinese loans.”
On 11 December, the U.S. Senate voted 55 to 44 to confirm Justin Muzinich to be Deputy Secretary of the Treasury.
SEC & Securities
Joint SEC and PCAOB Statement on the Vital Role of Audit Quality and Regulatory Access
On 7 December, SEC Chairman Jay Clayton, SEC Chief Accountant Wesley Bricker, and Public Company Accounting Oversight Board (“PCAOB”) Chairman William Duhnke III issued a joint statement entitled “The Vital Role of Audit Quality and Regulatory Access to Audit and Other Information Internationally—Discussion of Current Information Access Challenges with Respect to U.S.-listed Companies with Significant Operations in China.” In the joint statement, Clayton, Bricker, and Duhnke highlighted that information necessary for regulatory oversight of U.S.-listed companies with “substantial” overseas operations does not always “flow” to the U.S. capital markets regulators. They said that one of the biggest issues facing U.S. regulators and investors is the inability of the PCAOB to inspect audit work papers of PCAOB-registered auditing firms in China regarding their audit work of U.S.-listed companies. They note that “the flow of international capital investment presents challenges, not just for U.S.-listed companies and economic interests, but also for the SEC’s efforts to protect transparency and accountability in financial reporting globally.” Consequently, they said the SEC intends to “continue to work through these issues” by engaging in communication with international market regulators and law enforcement authorities. Regarding U.S.-linked companies that have operations in China, they said that the SEC and PCAOB face challenges in overseeing financial reporting. Their goal is to achieve a level of cooperation in the future with Chinese authorities that (i) “respects Chinese and U.S. sovereignty” and (ii) “enables the SEC and PCAOB to have timely access to the information necessary to conduct investigations or inspections.” Finally, the joint statement warned that if information barriers continue, then there remains a possibility that “remedial actions involving U.S.-listed companies may be necessary or appropriate.”
SEC Holds Its Annual Government-Business Forum on Small Business Capital
On 12 December, the SEC hosted its annual Government-Business Forum on Small Business Capital Formation to “explore how capital formation options are working for small businesses, such as those in the Midwest, and capital formation and diversity.” In his opening remarks before the forum, Chairman Clayton said that the SEC has a number of initiatives on its agenda for 2019 to help small businesses raise capital. The SEC will examine, among other things: (i) the “accelerated filer” definition and the thresholds that trigger Section 404(b) of the Sarbanes-Oxley Act, (ii) “expanding testing-the-waters accommodations that enable companies to engage in communications with certain potential investors prior to or following the filing of a registration statement”; (iii) “mandated quarterly reporting and the prevalence of optional quarterly guidance”; and (iv) “whether our reporting system more generally drives an overly short-term focus.”
SEC Extends AML No-Action Letter
On 12 December, the SEC’s Division of Trading and Markets extended the effectiveness of the no-action relief granted to certain broker-dealers that rely on registered investment advisers for compliance with anti-money laundering (“AML”) (i) Customer Identification Program Rules and (ii) Beneficial Ownership Requirements. The original letter was dated 12 December 2016 and addressed to the Securities Industry and Financial Markets Association. The effectiveness of the no-action position is extended until the earlier of: (1) the date upon which the AML Program Rule for investment advisers becomes effective, or (2) two years from the date of this letter” (12 December 2018).
SEC Holds Investor Advisory Committee Meeting
On 13 December, the SEC held an Investor Advisory Committee meeting to discuss: (i) disclosures on human capital, (ii) disclosures on ESG topics, and (iii) unpaid arbitration awards. In his opening remarks, SEC Chairman Jay Clayton said that the SEC has observed an increased number of issues around the disclosure of ESG information and requests for ESG information by investors. Clayton argued that companies should focus on material disclosure that investors need to make “informed investment and voting decisions” and that investors should focus on each company’s specific circumstances. In her opening remarks, SEC Commissioner Kara Stein said that some investors find it critical to understand ESG matters to “better assess [a] company’s performance.” In her opinion, the reason why 43 percent of the shareholder proposals submitted in 2018 focused on ESG issues is because certain investors believe there are “links between ESG matters and a company’s operational strength, efficiency, and management.” During the panel discussions, the general consensus amongst panelists was that they believe there would be benefits from the SEC developing consistent standards for the reporting of sustainability information. Specifically, Curtis Ravenel, Global Head, Sustainable Business & Finance, Bloomberg LP, argued that when ESG reporting is voluntary, companies will “cherry pick” the metrics that make them look best, rather than provide investors with a complete picture.
Joint Statement From CFTC Chairman Giancarlo and SEC Chairman Clayton on the IDI Exception to the Swap Dealer Definition
On 13 December, Commodity Futures Trading Commission (“CFTC”) Chairman Christopher Giancarlo and SEC Chairman Jay Clayton issued a joint statement on the insured depository institution (“IDI”) exception to the swap dealer definition. In the statement, the Chairmen said, “We are committed to continuing to engage and take action to better harmonize our agencies’ swap dealer and security-based swap dealer regulations under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). As part of this commitment, we wish to provide market participants with additional clarity regarding the treatment of swaps that [IDIs] enter into with customers in connection with originating loans.” Further, the Chairmen stated that they “recognize that it is important for both Commissions to provide market participants with consistent and comparable regulations to the extent practicable.”
CFTC & Derivatives
CFTC Requests Feedback on Crypto-asset Mechanics and Markets
On 11 December, the CFTC issued a Request for Input (“RFI”) seeking public comment and feedback “in order to inform the Commission’s understanding of the technology, mechanics, and markets for virtual currencies beyond Bitcoin, namely here Ether and its use on the Ethereum Network.” The CFTC is seeking “to understand similarities and distinctions between certain virtual currencies, including here Ether and Bitcoin, as well as Ether-specific opportunities, challenges, and risks.” The RFI requests comment on, among other things: (i) the “impetus for developing Ether and Ethereum Network, especially relative to Bitcoin”; (ii) the “current functionalities and capabilities of Ether and the Ethereum Network as compared to the functionalities and capabilities of Bitcoin”; (iii) how the “governance of the Ethereum Network [is] similar to and different from the governance of the Bitcoin network”; and (iv) how the “introduction of derivative contracts on Ether” would “potentially change or modify the incentive structures that underlie a proof of stake consensus model.” Comments on the Request for Information are due 60 days after its publication in the Federal Register.
On 11 December, President Donald Trump announced his intention to nominate Heath Tarbert as the next Chairman of the CFTC. CFTC Chairman Christopher Giancarlo’s term expires in April 2019.
OCC Reports Slight Improvement in Mortgage Performance
On 11 December, the Office of the Comptroller of the Currency (“OCC”) reported slight improvement in the performance of first-lien mortgages in the federal banking system during the third quarter of 2018. In the OCC’s OCC Mortgage Metrics Report, Third Quarter 2018, the report showed that “95.4 percent of mortgages included in the report were current and performing at the end of the quarter, compared to 94.8 percent a year earlier.” The report also showed that “servicers initiated 28,508 new foreclosures during the third quarter of 2018, a 3.7 percent decrease from the previous quarter and a 16.8 percent decrease from a year ago.” The report provides information on mortgage performance through 30 September 2018.
OCC Releases Third Quarter 2018 Bank Trading Revenue
On 12 December, the OCC released its Quarterly report on Bank Trading and Derivatives Activities: Third Quarter 2018. The report showed trading revenue of U.S. commercial banks and federal trading associations of $7.1 billion in the third quarter of 2018, which was $0.2 billion (2.7 percent) more than the previous quarter and $0.1 billion (1.7 percent) more than a year earlier. The report also found:
· “While four large banks held 89.8 percent of the total banking industry notional amount of derivatives, a total of 1,344 insured U.S. commercial banks and savings associations held derivatives at the end of the third quarter 2018.”
“Derivative contracts remained concentrated in interest rate products, which represented 75.7 percent of total derivative notional amounts.”
“The percentage of centrally cleared derivatives transactions increased to 40.7 percent in the third quarter 2018.”
· Dec. 17: Comments due on the Fed’s proposed rule that would “revise and expand its equal employment opportunity regulation to adopt recent changes the Equal Employment Opportunity Commission (EEOC) had made to its rules.”
· Dec. 17: Comments due on the CFTC’s proposed rule on the registration and compliance requirements for commodity poll operators and commodity trading advisors.
· Dec. 18: The Federal Deposit Insurance Corporation will hold an open meeting to consider, among other things: (i) a “Memorandum and resolution re: Notice of Proposed Rulemaking: Revisions to Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds”; (ii) a final rule on “Implementation and Transition of the Current Expected Credit Losses Methodology for Allowances and Related Adjustments to the Regulatory Capital Rule and Conforming Amendments to Other Regulations”; and (iii) a final rule on a “Limited Exception for a Capped Amount of Reciprocal Deposits from Treatment as Brokered Deposits.”
· Dec. 19: The FSOC will hold an open session.
· Dec. 19: The SEC will hold an Open Meeting to discuss: (i) PCAOB’s 2019 budget; (ii) a Request for Comment on earnings releases and quarterly reports; (iii) applications by security-based swaps dealers or major security-based swap participants for statutorily disqualified associated persons to effect or be involved in effecting security-based swaps; (iv) risk mitigation techniques for uncleared security-based swaps; (v) disclosure of hedging by employees or directors; and (vi) rule and rule amendments to allow “fund of funds” arrangements.
· Dec. 20: House Financial Services Committee hearing entitled “The Peril of an Ignored National Debt.”