US Regulatory Research
Democratic Lawmakers Send Letter to GAO Regarding Cybersecurity and Contribution Plans
On 12 February, Representative Robert Scott (D-VA) and Senator Patty Murray (D-WA) sent a letter to Gene Dodaro, Comptroller General of the U.S. Government Accountability Office (“GAO”), requesting the GAO to examine cybersecurity in the private retirement system. In the letter, the lawmakers said that the “cybersecurity safeguards, risks and liabilities for plan sponsors and participants remain ill-defined, especially with regard to major data breaches or advanced persistent threats." Scott and Murray further said that current law does not “address a number of questions related to cybersecurity, and plans fall within a patchwork of federal and state laws and regulations." The lawmakers asked the GAO to respond to a list of questions, including: “What potential threats do cyberattacks pose to U.S. retirement plan data and ultimately to plan participants’ financial well-being?”
Republican Senators Send Letter to GAO Seeking Clarification on Consolidated Supervision of Financial Institutions
On 22 February, Senators Thom Tillis (R-NC), Mike Crapo (R-ID), David Perdue (R-GA), Mike Rounds (R-SD), and Kevin Cramer (R-ND) sent a letter to the Government Accountability Office Comptroller General Gene Dodaro “to seek clarification on if guidance letters issued by the Federal Reserve imposing the framework for consolidated supervision of large financial institutions constitutes a ‘rule’ for purposes of the Congressional Review Act (CRA).” The five senators wrote that the “[t]his framework imposes substantive requirements relating to capital, liquidity, corporate governance, and recovery and resolution planning,” and, therefore, that ‘[d]etermining whether the guidance is a “rule” under the CRA is particularly important.”
SEC & Securities
SEC Will Not Recommend Enforcement Action Against Johnson & Johnson for Excluding a Mandatory Arbitration Shareholder Proposal
On 11 February, the Securities and Exchange Commission’s (“SEC”) Division of Corporation Finance recommended no-action to a request from Johnson & Johnson to omit a shareholder proposal from its 2019 proxy materials pursuant to Exchange Act Rule 14a-8(i)(2), which permits a company to exclude a shareholder proposal “[i]f the proposal, would, if implemented, cause the company to violate state, federal, or foreign law to which it is subject.” The proposal would have required shareholders to go to arbitration on federal securities law claims against the company. Johnson & Johnson successfully argued that the proposal would have caused the company to violate the state law of New Jersey, where the company is incorporated.
SEC Chairman Jay Clayton issued a statement of support to the approach taken by the SEC staff. Specifically, Chairman Clayton said, “In light of the unsettled and complex nature of this issue, as well as its importance, I agree with the approach taken by the staff to not address the legality of mandatory shareholder arbitration in the context of federal securities laws in this matter, and would expect our staff to take a similar approach if the issue were to arise again.
OCIE Issues Risk Alert on Transfer Agent Safeguarding of Funds and Securities
On 13 February, the SEC’s Office of Compliance Inspections and Examination (“OCIE”) issued a Risk Alert urging transfer agents to “review their practices, policies, and procedures to ensure funds and securities are protected while held at the transfer agent.” Examples of deficiencies that OCIE staff has observed in recent examinations include: (i) the misappropriation of shareholder funds and the theft of physical certificates; (ii) inadequate policies for the safeguarding of funds and securities; (iii) insufficient reconciliation controls and procedures; (iv) the failure to "secure access to vaults, computers and areas of the firm that handle disbursement operations"; (iv) the failure to send notifications to unresponsive payees; and (v) weaknesses in transfer agents' policies under the unresponsive payee rule.
SEC Proposes a New Rule to Allow Greater Flexibility for Institutional Investors
On 19 February, the SEC proposed a new rule that would permit issuers to communicate with certain potential investors to determine if such investors might be interested in a “contemplated registered securities offering.” The proposed rule would exempt such communications from restrictions under Securities Act Section 5. The purpose of the proposed rule is to provide more flexibility to issuers regarding their communications with institutional investors. The SEC said that the proposed rule would expand the “test-the-waters” accommodation to all issuers. The accommodation is currently only available to emerging growth companies. Comments on the proposed rule and amendments are due 60 days after their publication in the Federal Register.
SEC Settles Charges Against Unregistered ICO
On 20 February, the SEC announced that is had reached an agreement on a settlement offer with Gladius Network LLC regarding charges of “conducting an unregistered initial coin offering (ICO), which the company self-reported to the SEC.” The SEC’s press release stated, “The SEC did not impose a penalty because the company self-reported the conduct, agreed to compensate investors, and will register the tokens as a class of securities.”
SEC Reopens Comment Period for Proposed Amendments to Disclosure Requirements for Variable Annuity and Variable Life Insurance Contracts
On 21 February, the SEC reopened the comment period for its proposed amendments to improve disclosure for purchases of variable annuities and variable life insurance contracts. The proposed amendments would, among other things, allow an issuer to satisfy its prospectus delivery requirement for variable contracts by delivering a summary prospectus. Comments on the proposed rule are due by 15 March 2019.
CFTC & Derivatives
CFTC Announces Examination Priorities for its Compliance Division
On 12 February, the Commodity Futures Trading Commission’s (“CFTC”) Division of Market Oversight (“DMO”), Division of Swap Dealer & Intermediary Oversight (“DSIO”), and Division of Clearing and Risk (“DCR”) published their examination priorities.
· DMO: The DMO will focus on “emerging areas of self-regulation, where regulatory requirements and best practices may still be developing.” The DMO stated that it will conduct examinations in the following areas: (i) cryptocurrency surveillance practices; (ii) surveillance for disruptive trading; (iii) trade surveillance practices; (iv) block trade surveillance practices; (v) market surveillance practices; (vi) real-time market monitoring practices; (vii) practices around market maker and trading incentive programs; and (viii) derivatives contract markets' relationships with, as well as services received from, regulatory providers.
· DSIO: The DSIO said its examination priorities will include: (i) withdrawal of residual interest from customer accounts; (ii) accepted forms of non-cash margin; (iii) compliance with segregation requirements; (iv) futures commission merchants (“FCM”) use of customer depositories; (v) FCM customer account documentation; and (vi) swap dealer/major swap participant relationships with third-party vendors.
· DCR: The DCR said that its goal is to “identify areas of weakness or non-compliance in activities that are critical to a safe and efficient clearing process." The DCR will examine: (i) financial resources; (ii) risk management; (iii) system safeguards; and (iv) cyber-security policies, practices, and procedures.
CFTC Requests Comment on a Rule Amendment Certification Filing by ICE Futures U.S.
On 13 February, the CFTC requested public comment on a rule amendment certification by ICE Futures U.S., Inc. (“IFUS”). The amendment to IFUS Rule 4.26 “would allow for the implementation of Passive Order Protection (POP) Functionality,” which “is intended to reduce latency advantages between traders engaged in arbitrage strategies against related markets.” The proposed amendment would create a three-millisecond delay, or “speed bump,” for incoming orders that otherwise would transact immediately opposite resting or “passive orders.” The CFTC’s DMO extended the review period for proposed amendment for an additional 90 days until 14 May 2019.
CFTC Commissioners Submit Comment Letter to Fed, FDIC, and OCC Regarding Proposed SA-CCR Rule
On 15 February, CFTC Chairman Christopher Giancarlo and CFTC Commissioners Dan Berkovitz, Rostin Behnam, and Brian Quintenz submitted a comment letter with the Federal Reserve (“Fed”), Federal Deposit Insurance Corporation (“FDIC”), and Office of the Comptroller of the Currency (“OCC”) regarding their proposed rule “to implement a new approach for calculating the exposure amount of derivatives contracts under the agencies’ regulatory capital rules,” known as the standardized approach for counterparty risk (“SA-CCR”). The Commissioners said that the banking regulators “failure to acknowledge the risk-reducing impact of client initial margin in the calculation of the supplementary leverage ratio (“SLR”) has reduced the availability of clearing services in contravention of G20 mandates.” The adoption of SA-CCR without offset will, according to the Commissioners: (i) “maintain or increase the clearing members’ SLRs by more than 30 basis points on average”; (ii) continue to “disincentivize clearing members from providing clearing services”; and (iii) “limit access to clearing in contravention of G20 mandates and Dodd-Frank.” Commissioner Dawn Stump recused herself from providing commentary on the proposed rule.
CFTC Chairman Giancarlo Speaks on the U.S. Derivatives Markets
On 21 February, CFTC Chairman Christopher Giancarlo delivered remarks before the Department of Agriculture’s 95th Annual Outlook Forum. Chairman Giancarlo divided his remarks into six overall points. including:
· Commodity Derivatives Help Manage Production Risk: Giancarlo said that commodity derivatives “serve the needs of American society to help moderate price, supply and other commercial risks to free up capital for economic growth, job creation and prosperity” and that “when used properly” derivatives are “tools for efficient risk transfer and mitigation.”
· U.S. Commodity Futures Are a Global Product: Giancarlo said that “American derivatives markets are the world’s largest, most developed, and most influential” and argued that they are also “unmatched in efficient and undistorted price discovery.” However, Giancarlo cautioned that new entrants, such as China, are seeking to develop “commodity futures markets as viable regional price benchmarks for key industrial commodities.”
· Independent and Efficient Market Regulation: Giancarlo noted that the U.S. derivatives markets are the world’s “best regulated” and that there is a connection between the U.S. having the world’s most competitive markets and effective Federal regulation. He praised both the Obama and Trump Administrations for consistently abstaining “from interference in the CFTC’s regulatory mission,” He argued that the “insulation from political control and singular, dedicated regulation are among the key reasons why U.S. markets remain the world’s preeminent.”
In closing, Chairman Giancarlo said that the proper balance of sound policy, regulatory oversight and private sector innovation, new technologies and global trading will allow our markets to evolve in responsible ways, and continue to grow the economy and increase prosperity.”
On 15 February, CFTC Chairman Christopher Giancarlo announced that the CFTC is “seeking nomination for membership and public input” on the CFTC’s Agricultural Advisory Committee. The deadline for submissions is 1 March 2019.
OCC Proposes Amendments to its Company-Run Stress Testing Requirements
On 12 February, the OCC proposed amending its company-run stress testing requirements for national banks and federal savings associations, consistent with section 401 of the Economic Growth, Regulatory Relief and Consumer Protection Act (“EGRRCPA”). The proposal would, among other things: (i) “revise the minimum threshold for national banks and Federal savings association to conduct stress test from $10 billion to $250 billion”; (ii) “revise the frequency by which certain national banks and Federal savings associations would be required to conduct stress tests”; and (iii) “reduce the number of required stress testing scenarios from three to two.” Comments on the proposed amendments are due by 14 March 2019.
Agencies Jointly Release Final Rule on Private Flood Insurance
On 12 February, the Fed, FDIC, Farm Credit Administration, National Credit Union Administration, and OCC issued a joint final rule “to implement provisions of the Biggert-Waters Flood Insurance Reform Act of 2012 requiring regulated institutions to accept certain private flood insurance policies in addition to National Flood Insurance Program policies.” The rule, which takes effect on 1 July 2019, will: (i) implement “the Biggert-Waters Act requirement that regulated lending institutions accept private flood insurance policies that satisfy criteria specified in the Act”; (ii) allow “institutions to rely on an insurer's written assurances in a private flood insurance policy stating the criteria are met”; (iii) clarify “that institutions may, under certain conditions, accept private flood insurance policies that do not meet the Biggert-Waters Act criteria”; and (iv) allow “institutions to accept certain flood coverage plans provided by mutual aid societies, subject to agency approval.”
Fed Chairman Powell Speaks on Economic Development in Rural Communities
On 12 February, Fed Chairman Jerome Powell delivered remarks entitled “Encouraging Economic Development in High-Poverty Rural Communities.” In his speech, Chairman Powell noted that while the U.S. economy remains strong, much of that prosperity “has not been felt as much in some areas, including many rural places.” He said that one of the reasons for this disparity is that many rural areas “lack diverse industries and employment options” and that those areas are more susceptible to automation and outsourcing. Powell outlined three ways to shrink the prosperity disparity between rural and urban areas: (i) education and workforce development; (ii) entrepreneurship and small business development; and (iii) increased access to “safe and affordable” financial services. Regarding access to financial services, Powell said that “[r]egulation and supervision need to be carefully tailored to suit the size and business model of different types of institutions.” He noted that the Fed has “renewed” its efforts to “avoid unnecessary regulatory burden on community banks, which provide credit in their local communities.”
Fed Identifies an Error In the Historical Dataset Used in its 2019 Stress Tests and Issues a Correction
On 13 February, the Fed announced that it had identified an error in the historical dataset used in its 2019 stress tests and issued a correction. In the fourth quarter 2018, the mortgage rate “was originally published as 4.6 percent and should have been 4.8 percent.” The Fed also stated that “[a]ll other variables, both their historical values and projected values in the hypothetical scenarios, are unchanged.” The OCC released a similar statement noting the historical dataset correction.
Agencies Extend Comment Period on Proposed Rule for Derivatives Contracts
On 15 February, the Fed, FDIC, and OCC extended until 18 March 2019, the comment period for “a proposed rule to update their standards for how firms measure counterparty credit risk by derivative contracts.” The proposal, originally released on 30 October 2018, would provide “’standardized approach for measuring counterparty credit risk,’ also known as ‘SA-CCR’ as an alternative approach to the agencies' current exposure methodology, or CEM, for calculating derivative exposure under the agencies' regulatory capital rules.”
Fed Extends Comment Period for Proposed Rule on Company-Run Stress Tests
On 15 February, the Fed extended the comment period for its proposed rule that would modify company-run stress testing requirements to conform with the EGRRCPA. Comments are now due on 21 March 2019.
FOMC Releases Minutes from Its January 2019 Meeting
On 20 February, the Fed and the Federal Open Markets Committee (“FOMC”) released the minutes of the FOMC’s 29-20 January meeting. According to the minutes, “Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year. Such an announcement would provide more certainty about the process for completing the normalization of the size of the Federal Reserve’s balance sheet.” The minutes also said that “[p]articipants pointed to a variety of considerations that supported a patient approach to monetary policy at this juncture as an appropriate step in managing various risks and uncertainties in the outlook.” Among the considerations were the recent softness in inflation, the U.S. federal government shutdown, and the path of fiscal policy. FOMC members said that holding the federal funds rate in a target range of 2.25 percent to 2.5 percent “posed few risks at this point.” The next FOMC meeting will be held on 19-20 March 2019.
Fed Issues Monetary Policy Report
· “The labor market has continued to strengthen since the middle of last year.”
· “Consumer price inflation, as measured by the 12-month change in the price index for personal consumption expenditures, moved down from a little above the FOMC’s objective of 2 percent in the middle of last year to an estimated 1.7 percent in December, restrained by recent declines in consumer energy prices.”
· “Available indicators suggest that real gross domestic product (GDP) increased at a solid rate, on balance, in the second half of last year and rose a little under 3 percent for the year as a whole – a noticeable pickup from the pace in prior years.”
Fed Vice Chairman Clarida Speaks on the Fed’s Monetary Policy Strategy
On 22 February, Fed Vice Chairman Richard Clarida delivered remarks before the 2019 U.S. Monetary Policy Forum in a speech entitled “The Federal Reserve’s Review of Its Monetary Policy Strategy, Tools, and Communication Practices.” In his remarks, Vice Chairman Clarida said that the Fed believes “our existing framework has served us well” by “helping us effectively achieve our statutorily assigned dual-mandate goals of maximum employment and price stability.” However, he noted that “in light of the unprecedented events of the last decade,” now is the time to look back and assess possible ways in which to improve the Fed’s strategy, tools, and communication practices “to achieve and maintain these goals as consistently and robustly as possible.” Regarding the scope of the review, Clarida said that the Fed’s review this year “will take this statutory mandate as given and will also take as given that inflation at a rate of 2 percent is most consistent over the longer run with the congressional mandate.” He said the review will be “wide ranging” and that the Fed “will not prejudice where it will take us.” Next, Clarida outlined three questions the Fed will ask itself during the review:
· "Can the Federal Reserve best meet its statutory objectives with its existing monetary policy strategy, or should it consider strategies that aim to reverse past misses of the inflation objective?"
· "Are the existing monetary policy tools adequate to achieve and maintain maximum employment and price stability, or should the toolkit be expanded? And, if so, how?"
· "How can the FOMC's communication of its policy framework and implementation be improved?"
Finally, Clarida outlined the activities and timeline for the review, saying that the Fed will conduct several town hall-style “Fed Listens” events this year, sponsor a System research conference on 4-5 June 2019, and share its conclusions with the public in the first half of 2020.
Fed Vice Chairman for Supervision Quarles Speaks on the Fed’s Balance Sheet
On 22 February, Fed Vice Chairman For Supervision Randal Quarles delivered remarks before the 2019 U.S. Monetary Policy Forum in a speech entitled “The Future of the Federal Reserve’s Balance Sheet.” In his remarks, Vice Chairman Quarles laid out a “rough framework for some further issues that are on the horizon.” He noted that in January, the FOMC “announced its intent to continue operating in a framework of ample reserves.” He said that the most important factor in the decision was that “the current system has worked very well” and it “has supported the achievement of our dual-mandate objectives of maximum employment and price stability.” Regarding the “natural next step” to contemplate the appropriate size of the Fed’s balance sheet and reserves, Quarles said that “the Fed will maintain a larger balance sheet and reserve supply relative to the pre-crisis period, with the goal of remaining on the flat portion of the reserve demand curve.” Further, Quarles said that “the size of the balance sheet will be determined by a number of factors, including demand for nonreserve liabilities, such as currency (which has been rising), and, importantly, the quantity of reserves necessary to remain reliably on the flat portion of the reserve demand curve.” Regarding the long-term, Quarles stated that “once we reach our preferred level of reserves, the balance sheet would have to resume growth to match a continued increase in demand for nonreserve liabilities.” Finally, Quarles asserted that (i) the “normalization of the balance sheet is not a competing goal,” and (ii) if it ever appears that the Fed’s plans for the balance sheet are “running counter to the achievement of our dual-mandate objectives,” then the Fed would “quickly reassess our approach to the balance sheet.”
Treasury Releases International Capital Data for December 2018
On 15 February, the Department of the Treasury (“Treasury”) released its Treasury International Capital (“TIC”) data for December 2018. The Treasury’s press release stated, “The sum total in December of all net foreign acquisitions of long-term securities, short-term U.S. securities, and banking flows was a net TIC outflow of $33.1 billion. Of this, net foreign private outflows were $2.3 billion, and net foreign official outflows were $30.7 billion.” The release further stated that “U.S. residents “decreased their holdings of long-term foreign securities, with net sales of $43.1 billion,” and “[f]oreign residents increased their holdings of U.S. Treasury bills by $2.1 billion.” The next release, which will report on data for January 2019, is scheduled for 15 March 2019.
· Feb. 26: House Committee on Appropriations’ Subcommittee on Financial Services and General Government will hold a hearing entitled “Leveraging Private Capital For Underserved Communities and Individuals: A Look Into Community Development Financial Institutions (CDFIs).”
· Feb. 26: House Committee on Energy and Commerce’s Subcommittee on Consumer Protection and Commerce will hold a hearing entitled “Protecting Consumer Privacy in the Era of Big Data.”
· Feb. 26: House Committee on Financial Services (“House Financial Services Committee”) will hold a hearing entitled “Who’s Keeping Score? Holding Credit Bureaus Accountable and Repairing a Broken System.”
· Feb. 26: House Financial Services Committee will hold a hearing entitled “Monetary Policy and the State of the Economy.”
· Feb. 26: Senate Committee on Banking, Housing, and Urban Affairs (“Senate Banking Committee”) will hold an Executive Session to consider several nominations including Mark Calabria to be Director of the Federal Housing Finance Agency and Bimal Patel to be Assistant Secretary of the Treasury for Financial Institutions.
· Feb. 26: Senate Committee on Banking, Housing, and Urban Affairs will hold a hearing entitled “The Semiannual Monetary Policy Report to the Congress.”
· Feb. 26: CFTC Commissioner Rostin Behnam will participate in a panel at the Structured Finance Industry Group Vegas 2019 Conference.
· Feb. 26-27: Fed Chairman Jay Powell will appear before the Senate Banking Committee and House Financial Services Committee regarding the Fed’s Monetary Policy Report discussed above.
· Feb. 27: CFTC Chairman Christopher Giancarlo and CFTC Commissioners Brian Quintenz and Dan Berkovitz will each give a keynote address at DerivCon 2019.
· Feb. 27: House Financial Services Committee will hold a hearing entitled “An Overview of Diversity Trends in the Financial Services Industry.”
· Feb. 27: Senate Committee on Small Business will hold a hearing entitled “Supporting America’s Startups: Review of SBA Entrepreneurial Development Programs.”
· Feb. 28: Senate Banking Committee will hold a hearing entitled “Legislative Proposals on Capital Formation and Corporate Governance.”