US Regulatory Update
Senate Banking Committee Holds Hearing on the Proxy Process
On 6 December, the U.S. Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled “Proxy Process and Rules: Examining Current Practices and Potential Changes.” Testifying at the hearing were: Daniel Gallagher, Chief Legal Officer of Mylan N.V.; Michael Garland, Assistant Comptroller for Corporate Governance and Responsible Investment at the Office of the Comptroller of the Currency of New York City; and Thomas Quaadman, Executive Vice President at the U.S. Chamber Center of Capital Markets Competitiveness. In his opening statement, Committee Chairman Michael Crapo (R-ID) said, “It is time to re-examine the standards for inclusion of these proposals as well as the need for fiduciaries to vote all proxies on all issues in light of the proliferation of environmental, social or political proposals, and the rise of diversified passive funds.” Mr. Gallagher testified that the current shareholder environment makes investors rely on proxy advisory firms in a way that was not anticipated by the securities laws when they were first drafted. Gallagher said that previous Securities and Exchange Commission (“SEC”) rulemakings have had unintended consequences, including “a direct increase in the extent to which for-profit third-party proxy advisors, which have no economic risk in the underlying investments, drive decision making at investment advisers and corporations.” Further, he argued that proxy advisor research often is “just not good enough, and proxy advisory firms publish some recommendations that are based on clear, material mistakes of fact.” Moreover, [proxy advisory firms] base some recommendations on a cookie-cutter approach to governance … even if there is a sound basis for challenging the assumption that an otherwise beneficial governance reform might not be appropriate for a given company.” Regarding the vocal critics of proxy advisory firms, Mr. Garland argued that “many of those who are the subject of the proxy analysis do not like to be criticized and receive negative vote recommendations, so they are reportedly lobbying aggressively and inappropriately to insert themselves between the proxy advisors and the clients of those advisors.” Mr. Quaadman said that the U.S. Chamber of Commerce “strongly supports” the bipartisan H.R. 4015, the Corporate Governance Reform and Transparency Act, saying that it “will provide for much needed transparency and oversight by requiring proxy advisory firms to disclose conflicts of interest, grant companies sufficient time to respond to voting recommendations, and require that firms demonstrate their capabilities to provide fair and accurate voting recommendations.”
SEC & Securities
SEC Commissioner Peirce Speaks on the State of Securities Regulation
On 28 November, SEC Commissioner Hester Peirce delivered remarks before the Exchequer Club in a speech entitled “Regulatory Apparitions.” In her remarks, Peirce called on the SEC to reexamine its rules on a regular basis “to ensure that they continue to effectively and efficiently advance the regulatory mandate Congress has given” the SEC. She said that if a rule is not solving the problem the SEC sets out to solve, then it is important for the Commission to figure out other solutions and eliminate the rule if the problem no longer exists. Peirce argued that “outdated rules can impose significant costs on market participants” and for that reason, she opposes specific technology requirements in SEC rules. Specifically, she said, “We ought to consider whether it is time to allow firms the flexibility to use some of these more cost-effective [technological] approaches – methods that integrate seamlessly with the firm’s operations.” Finally, she applauded the SEC’s practice of retrospective review, noting the Commission’s recent reconsideration of rules related to the proxy process, capital formation, and market structure.
SEC Co-Director of Enforcement Speaks on International Cooperation on SEC Enforcement
On 3 December, Steven Peikin, the SEC’s Co-Director of Enforcement, delivered remarks at the IOSCO/PIFS-Harvard Law School Global Certificate Program for Regulators of Securities Markets in a speech entitled “The Salutary Effects of International Cooperation on SEC Enforcement.” In his remarks, Peikin noted three areas where international cooperation is crucial for the SEC’s enforcement program: (i) initial coin offerings (“ICOs”); (ii) Foreign Corrupt Practices Act (“FCPA”) violations; and (iii) microcap and other securities fraud. He said that the growth in the ICO market has concealed the fact that ICOs are “high-risk investments” and that the sponsors of many ICOs are located outside of the U.S., making international cooperation “critical” in these cases. Regarding FCPA violations, Peikin argued that U.S. authorities should not “go it alone in fighting corruption,” particularly because the global markets have become increasingly interconnected. However, he cautioned that despite an “upward trajectory in international cooperation on enforcement matters,” barriers to information sharing still exist in various forms,including data protection, privacy, confidentiality, bank secrecy, state secrecy, or national securities laws.
SEC Chairman Clayton Speaks on SEC Rulemaking Over the Past Year
On 6 December, SEC Chairman Jay Clayton delivered remarks entitled “SEC Rulemaking Over the Past Year, the Road Ahead and Challenges Posed by Brexit, LIBOR Transition and Cybersecurity Risks.” In his remarks, Clayton discussed the SEC’s progress on its agenda for 2018, its agenda for 2019, and his observations on key risk that the SEC is monitoring in 2019. Regarding the SEC’s 2018 regulatory agenda, he highlighted three areas of the Commission’s work: (i) improving the regulation of investment professionals (highlighting the SEC’s recent proposed rulemakings on the fiduciary standard for investment advisers), (ii) facilitating capital formation (highlighting the SEC’s expansion of the definition of “smaller reporting company” and its recently adopted final rules that eliminate outdated, overlapping, or duplicative requirements), and (iii) monitoring and reacting to the U.S.’ evolving securities markets (highlighting the three roundtables held by the Division of Trading and Markets on key market issues). Regarding the SEC’s 2019 initiatives, Clayton said the November 2019 roundtable on the proxy process showed “consensus among the panelists that the proxy ‘plumbing’ needs a major overhaul,” and he encouraged market participants to comment on what such an overhaul will look like and how technology can help facilitate improvements. Further, Clayton said the staff is considering many of the issues raised at the roundtable, including: (i) “the framework for addressing conflicts of interests at proxy advisory firms” and (ii) “ensuring that investors have effective access to issuer responses to information in certain reports from proxy advisory firms.” Next, Clayton said he expects the SEC to continue to spend a “significant amount of time” on distributed ledger technology, digital assets, and ICOs. He said, “I believe that “ICOs can be effective ways for entrepreneurs and others to raise capital. However, the novel technological nature of an ICO does not change the fundamental point that, when a security is being offered, our securities laws must be followed.” Finally, Clayton discussed three areas of market risks that the SEC will be monitoring. First, Clayton believes that potential effects of Brexit will be international, reaching U.S. markets and Main Street investors. Second, Clayton sees a significant risk for many market participants regarding how banks “manage the transition from LIBOR to a new rate such as SOFR, particularly with respect to those existing contracts that will still be outstanding at the end of 2021” when it is expected that most banks will stop reporting information set to LIBOR. Finally, Clayton believes that cybersecurity is something that the agency needs to look at from a number of perspectives, including: (i) disclosure of material cybersecurity risks and incidents, (ii) market oversight of how firms prepare for a cybersecurity threat, safeguard customer information, and detect red flags, and (iii) the targeting of cyber-related misconduct in our market.
SEC Holds Conference on Municipal Securities Disclosure
On 6 December, the SEC Commissioners and the Office of Municipal Securities held a one-day conference focused on municipal securities disclosure entitled “The Road Ahead: Municipal Securities Disclosure in an Evolving Market.” In his opening remarks, SEC Chairman Jay Clayton argued that there needs to be a continual and proactive regulatory focus on the municipal securities market because this market is “ever-changing.” “This includes staying abreast of relevant macroeconomic trends and other factors, such as interest rate changes and changes in tax laws,” Clayton said. Regarding municipal securities disclosures, Clayton believes that “providing greater clarity regarding existing municipal issuer financial disclosure practices will provide investors and the market with better access to valuable information.” In her opening remarks, Commissioner Kara Stein championed recent innovations in the municipal securities market, such as “green muni bonds,” in which an issuer agrees to use all of the bond proceeds for environmentally friendly purposes. She said such innovations have “further democratized access to the muni bond market” and decreased the spreads on smaller trades. However, with respect to disclosure and technology, Stein said that “more work needs to be done” to further improve the municipal bond market. Finally, in her opening remarks, SEC Office of Municipal Securities Director Rebecca Olsen argued that improvements to disclosures should ensure that investors have “timely access to current material information” and that she “believe[s] it is essential that disclosure practices evolve.” Olsen pointed to the Commission’s recent amendments to Exchange Act Rule 15c2-12, which require municipal securities issuers to disclose material financial obligations that could impact an issuer’s liquidity and overall creditworthiness, as an example of the SEC’s commitment to improving the disclosure process.
CFTC & Derivatives
CFTC Commissioner Quintenz Speaks on Global Financial Markets
On 1 December, Commodity Futures Trading Commission (“CFTC”) Commissioner Brian Quintenz delivered remarks before the 14th Annual China International Derivatives Forum. In his remarks, Quintenz said he disagreed with the portrayal of derivatives as “inherently ‘risky,’” saying that derivatives present tools to manage and efficiently transfer risk to market participants who can bear it. He argued that derivatives are vital to the “health and growth of a country’s real economy” and said that China should adopt an approach to future market regulation similar to that taken by the CFTC. Regarding the regulation of the U.S. futures market, Quintenz opined that there are three characteristics that have “significantly contributed” to the “resiliency, vitality, and efficiency” of the U.S. futures markets: “[i] participant diversity, [ii] customer protection, and [iii] the promotion of market integrity through principles-based regulations.” He added that the U.S. policy of open participation has helped increase liquidity and that the legal regime supporting the U.S. futures markets has led to strong customer protections. Finally, Quintenz said that the growth of the Chinese futures markets has been “critical” to its economic rise.
CFTC’s MRAC Holds Meeting on Clearinghouse and Vendor Risk Management
On 4 December, the CFTC’s Market Risk Advisory Committee (“MRAC”) held a meeting to discuss (i) clearinghouse governance structures and risk management, (ii) management of non-default losses in recovery and resolution, and (iii) recent reports, discussion papers, and proposed rules involving global standard-setting bodies and prudential regulations. At the meeting, CFTC Commissioner Rostin Behnam, the sponsor of the MRAC, focused on issuers “related to clearing, including the roles and responsivities of central counterparties. . .in monitoring and managing the variety of risks arising from stresses including, but not limited to, a clearing member default.” Further, Behnam praised the “tectonic shift” that the clearing mandate has fostered in the swaps marketplace, but cautioned that “these benefits have not come without costs, and there remain concerns regarding whether the regulatory structure properly accounts for risk in terms of capital, margin, and leverage.” Also at the meeting, the MRAC announced the appointment of the members of the recently established Interest Rate Benchmark Reform Subcommittee.
CFTC Chairman Giancarlo Issues Statement on Brexit
On 6 December, CFTC Chairman Christopher Giancarlo issued a statement on financial stability concerns regarding Brexit. Giancarlo said that the “[u]ncertainty surrounding the effect of Brexit on the U.K. and EU27 financial markets is already having a substantial impact on entities and markets regulated by the CFTC.” He warned that if not eliminated, such uncertainty has “the potential to create instability in the global derivatives market.” He argued that derivative market participants should have more detail and clarity from European authorities as to: (i) “when the proposed equivalence decision for the U.K. and recognition decision for U.K. CCPs [central clearinghouses] will be made”, (ii) “whether the equivalence and recognition decisions will apply to all cleared products or only to derivatives”, and (iii) whether the equivalence and recognition decisions will apply to both new and existing cleared transactions.” Giancarlo believes that the additional clarity and certainty will help mitigate “operational and market risks” that will result from the transfer of “potentially trillions of euros in swap exposures” before a potential no-deal Brexit.
U.S. Treasury Market Structure Conference
In order to better understand the key factors underlying the evolution of the Treasury market's current structure and liquidity, the Department of the Treasury (“Treasury”), the Board of Governors of the Federal Reserve System (“Fed”), the Federal Reserve Bank of New York, the SEC, and the CFTC held the Fourth Annual Conference on the Evolving Structure of the U.S. Treasury Market on 3 December, which included remarks from CFTC Chairman Christopher Giancarlo, Fed Governor Lael Brainard, and Craig Phillips, Counselor to the Secretary of the Treasury.
CFTC Chairman Giancarlo
In his remarks, Giancarlo said that he has reviewed the findings of a recent study by the Office of the Chief Economist of the CFTC on the relative liquidity of exchange-traded futures contracts and cash securities in the US Treasuries market. Specifically, Giancarlo said that the study illustrates a “highly complex and dynamic ‘liquidity hierarchy’ in the U.S. Treasury market.” According to Giancarlo, the study showed that: (i) “while overall risk volume is greater across all cash securities than across all futures contracts, the liquidity hierarchy is more complex, with certain futures contracts more liquid than certain cash securities, and vice versa”; (ii) “[t]he relative amount of risk traded through futures contracts is higher on days with large price movements”; and (iii) “average trade size, in risk terms, is much higher for cash securities than for future contracts.” Finally, he said the study also found, among other things, that: (i) “as volatility increases, liquidity migrates from less liquid cash securities to more liquid futures contracts” and (ii) generally “futures are a bigger fraction of risk transfer outside of U.S. trading hours.”
Fed Governor Brainard
On 3 December, Fed Governor Lael Brainard delivered remarks at The Evolving Structure of the U.S. Treasury Market: Fourth Annual Conference in a speech entitled “The Structure of the Treasury Market: What Are We Learning?” In her remarks, Brainard announced that the Fed is close to finalizing an agreement to start collecting Treasury market data from banks under a soon to be finalized agreement with the Financial Industry Regulatory Authority (“FINRA”). Under the agreement, FINRA would act as the Fed’s agent to collect transactions from key banks. Brainard said that the expanded data collection “will help round out [regulators’] view of these markets and ensure continuous coverage in circumstances where trading moves between the bank and the broker-dealer within a firm.” She also said that the Fed “has decided to issue a notice of proposed rulemaking to seek public comment on collecting agency mortgage-backed securities (MBS) and debt transactions” and that “[t]his collection will help round out the IAWG's [interagency working group] view of these markets and ensure continuous coverage in circumstances where trading moves between the bank and the broker-dealer within a firm.”
Counselor to the Secretary of the Treasury Phillips Speaks on Market Structure
On 3 December, Craig Phillips, Counselor to the Secretary of the Treasury, delivered a presentation on market structure at The Evolving Structure of the U.S. Treasury Market: Fourth Annual Conference. In his remarks, Phillips focused on the Treasury securities transaction data collected by FINRA through its Trade Reporting and Compliance Engine (“TRACE”) from FINRA’s member broker-dealers. From the TRACE data, Treasury has learned that the average daily transaction volumes are almost $600 billion per day, largely split between the “dealer to customer” market and the “interdealer broker” market. The data also showed that the median trade size for most coupon securities is $1 to $5 million. Phillips said there are three major takeaways from the data: (i) “trading volumes and pricing in both on-the-run and off-the-run securities are robust”; (ii) “Treasury experiences tremendous continuity between secondary trading levels and the primary auction process”; and (iii) “the market structure is well functioning.” He also said that Treasury has identified areas for improvement in the quality of TRACE data for Treasury securities transactions, including:
· “The granularity of timestamps need to be refined due to characteristics of the Treasury market, such as the high frequency nature of electronic trades and the workup.”
· “Fees are included as part of some prices. For Treasury security trades, these fee add-ons need to be normalized to have meaningful pricing information and trade matching.”
· “There appear to be some data reporting inconsistencies that suggest the need for additional checks and further clarification to reporters to standardize the reporting,”
· “Accurately matching trades can be challenging, which is critical to properly size the market.”
Finally, Phillips said that the Treasury plans to “continue to work toward resolving the data quality issues” and that the Treasury will “consider a cross-section of volume data by security type and transaction venue in aggregated form” before considering a policy decision regarding the dissemination of transaction-level TRACE data.
Agencies Release Joint Statement on Money Laundering and Terrorist Financing
On 3 December, the Fed, Federal Deposit Insurance Corporation (“FDIC”), Treasury’s Financial Crimes Enforcement Network (“FinCEN”), National Credit Union Administration, and Office of the Comptroller of the Currency (“OCC”) released a joint statement on innovative efforts to combat money laundering and terrorist financing. In the joint statement, the agencies urged banks to pursue innovative approaches to meeting Bank Secrecy Act/Anti-Money Laundering (“BSA/AML”) compliance obligations. Innovation includes the use of artificial intelligence, digital identity technologies, and internal financial intelligence unites. The agencies believe that such innovations have the potential to augment banks’ programs for risk identification, transaction monitoring, and suspicious activity reporting. The agencies also said that they will establish projects or offices that will work to support the implementation of responsible innovation and new technology in the financial system. Finally, they said that the implementation of innovative approaches to BSA/AML compliance will not result in additional regulatory expectations.
OCC Releases Report on the Key Risks for the Federal Banking System
On 3 December, the OCC released its Semiannual Risk Perspective for Fall 2018, which covers the risks facing national banks and federal savings associations based on data as of 30 June 2018. The report presents information in five main areas: (i) the operating environment, (ii) bank performance, (iii) special topics in emerging risk, (iv) trends in key risks, and (v) supervisory actions. Highlights from the report include:
· “Credit quality remains strong, but the OCC is monitoring the origination quality of new loans, the potential for increased lender complacency within credit risk identification and management, and the potential embedded risks from successive years of eased underwriting.”
· “Operational risk is elevated as banks respond to an evolving and increasingly complex operating environment.”
· “Compliance risk is elevated as banks manage money laundering risks and comply with amended consumer protection requirements.”
· “Rising interest rates and increased competition for deposits may result in changes in funding mix or costs.”
Treasury Under Secretary Mandelker Delivers Remarks on AML/CFT Regime
On 3 December, Treasury Under Secretary for Terrorism and Financial Intelligence Sigal Mandelker spoke to the American Bankers Association-American Bar Association Financial Crimes Enforcement Conference. Mandelker’s remarks focused on efforts to “strengthen domestic and international anti-money laundering/countering the financing of terrorism (AML/CFT) safeguards.” She spoke at length about recent efforts by the United States to fully enforce the sanctions on the Iranian regime. She also noted that FinCEN has ramped its advisory program across a range of illicit finance threats, including “deceptive financial practices that Iran uses” and “illicit finance risks associated with North Korea, Venezuela, Nicaragua, and political corruption in South Sudan.” Mandelker highlighted the joint statement issed by FinCEN and other agencies on money laundering and terrorist financing (discussed above). She emphasized that “[t]he joint statement recognizes that private sector innovation, including new ways of using existing tools or by adopting new technologies, can be an important element in safeguarding the financial system against an evolving array of threats.”
Fed Releases FOMC Minutes from its 8 November Discount Rate Meeting
On 4 December, the Fed released the minutes of its 8 November Federal Open Market Committee (“FOMC”) discount rate meeting. According to the minutes, the FOMC and the Board decided to maintain the target range for the federal funds rate at 2 to 2.25 percent. In addition, “[c]onsistent with the FOMC's decision to leave the target range for the federal funds rate unchanged, the Board approved maintaining the existing interest rate (2.20 percent) paid on required and excess reserve balances.” The directors of the twelve Federal Reserve banks “remained positive about the economic outlook and had favorable reports on various economic conditions across their Districts.” In their decision to establish the primary credit rate at the current level of 2.75 percent, all twelve of the directors “judged that it would be appropriate to maintain the current level of short-term interest rates and assess whether incoming data support the outlook for continued economic growth, strong labor market conditions, and inflation remaining near 2 percent.”
Fed Releases October Beige Book
On 5 December, the Fed released its November Beige Book, a publication about current economic conditions across the twelve Fed Districts through 26 November. According to the publication, the twelve Fed Districts reported that their economies expanded at a “modest or moderate pace” from mid-October through late November. The publication found that labor markets have tightened further across a broad range of occupations as expansion has sometimes been “constrained by an inability to attract and retain qualified workers.” Regarding prices, the publication found that “[o]n balance, prices rose at a modest pace in most Districts, although a few noted moderate increases” and that “[r]eports of tariff-induced cost increases have spread more broadly from manufacturers and contractors to retailers and restaurants.”
Fed Governor Brainard Speaks on the Fed’s Financial Stability Outlook
On 7 December, Fed Governor Lael Brainard delivered remarks at the Peterson Institute for International Economics in a speech entitled “Assessing Financial Stability over the Cycle.” In her remarks, Brainard touched on a number of issues relating to the current state of the economy, with some of her more significant comments being:
· “Today employment is strong, inflation is around target, and incomes are growing.”
· “The economy has grown 3 percent over the past year, and there are good reasons to expect growth to remain solid next year, supported by the strong underlying momentum in domestic demand.”
· “The most likely path for the economy is positive, although some tailwinds that have provided a boost are fading, and we may face some crosscurrents. The global growth that provided a strong tailwind going into this year has moderated. The earlier strong growth in Europe and Japan appears to be softening toward trend.”
· “While there has been substantial progress on reducing household debt burdens and increasing the resilience of the banking system, the Federal Reserve’s assessment suggest that financial vulnerabilities associated with corporate debt are building against a backdrop of elevated risk appetite.”
· “Reinforcing capital buffers during the strong part of the cycle means that banks will have cushion to absorb losses and remain sound during a subsequent downturn. Thicker capital buffers help bolster the confidence of market participants when conditions deteriorate, helping prevent the downward spiral from a loss of confidence.”
· Dec. 11: Senate Banking Committee hearing entitled “Oversight of the U.S. Securities and Exchange Commission.”
· Dec. 11: House Financial Services Committee hearing entitled “The National Debt: Washington, We Have a Spending Problem.”
· Dec. 11: House Financial Services Committee hearing entitled “Assessing the Impact of FASB’s Current Expected Credit Loss (CECL) Accounting Standard on Financial Institutions and the Economy.”
· Dec. 12: House Financial Services Committee hearing entitled “Evaluating the Effectiveness of the International Financial Institutions.”
· Dec. 12: SEC will hold its annual Government-Business Forum on Small Business Capital Formation.
· Dec. 13: SEC’s Investor Advisory Committee will hold a meeting to discuss: (i) disclosures on human capital; (ii) disclosures on Sustainability and Environmental, Social, and Governance topics; and (iii) unpaid arbitration awards.
· Dec. 14: Comments due on potential Fed actions to support interbank settlement of faster payments.