US Regulatory Research
FINRA Publishes CAT Onboarding Guide
On 31 July, the Financial Industry Regulatory Authority (“FINRA”) published a Consolidated Audit Trail (“CAT”) Industry Member Onboarding Guide to assist reporting entities in gaining access to the CAT Test and Production Environments for the first time. The Onboarding Guide outlines the steps industry members and reporting agents must complete in order to gain access to CAT, including: (i) registering for CAT; (ii) designating CAT account administrators; (iii) establishing and managing connectivity to CAT; (iv) establishing ATS order types, where applicable; and (v) conducting and certifying CAT testing.
Senate Banking Committee Holds Hearing on the Regulatory Framework for Cryptocurrencies and Digital Assets
On 30 July, the U.S. Senate Committee on Banking, Housing, and Urban Affairs (“Senate Banking Committee”) held a hearing entitled “Examining Regulatory Frameworks for Digital Currencies and Blockchain.” Testifying at the hearing were: Jeremy Allaire, Co-Founder, Chairman and Chief Executive Officer, Circle Internet Financial Limited, on behalf of The Blockchain Association; Rebecca Nelson, Specialist in International Trade and Finance, Congressional Research Service; and Mehrsa Baradaran, Professor of Law, University of California, Irvine School of Law. Allaire said, “I believe that blockchains and digital assets will be viewed as more impactful than the rise of joint stock corporations, double entry bookkeeping, and modern banking.” He also testified that Circle was moving its assets out of the United States due to the uncertain legal and regulatory environment for digital assets. Nelson presented a brief overview of current trends and concerns, including the patchwork of regulations, various approaches nations are taking to blockchain, and concerns raised about Libra. Baradaran spoke against blockchain and cryptocurrencies. She argued that “[p]ractically speaking, the most direct path to financial inclusion is by opening the doors to our already established payment system” and that “[i]t can and must be updated.” She added, “But the system is secure, handles millions of transactions a day, is accepted by all merchants, and is widely understood.” Senators’ questions aimed to differentiate the different uses of blockchain to determine an appropriate regulatory framework. Allaire argued for a single regulator, but not the Securities and Exchange Commission (“SEC”), to regulate the technology. Baradaran was more concerned about regulating the applications of blockchain instead of the underlying technology. Committee Chairman Mike Crapo (R-ID) and Senator Chris Van-Hollen (D-MD) used the hearing as another opportunity to urge the Federal Reserve (“Fed”) to facilitate a faster-payments system, which Baradaran endorsed. Lastly, several members rehashed concerns about Libra and Facebook, including how Libra would operate across jurisdictions and how exactly Libra would stabilize its value.
Chairwoman Waters and Ranking Member Brown Send Letter to Banking Regulators
On 1 August, Representative Maxine Waters (D-CA-43), Chair of the U.S. House Committee on Financial Services (“House Financial Services Committee”), and Senator Sherrod Brown (D-OH), Ranking Member of the Senate Banking Committee, sent a letter to Fed Chairman Jerome Powell, Jelena McWilliams, Chairman of the Federal Deposit Insurance Corporation (“FDIC”), and Joseph Otting, Comptroller of the Office of the Comptroller of the Currency (“OCC”). The letter urged the banking regulators to maintain the current requirements to post initial margin for any swap transaction between insured depository institutions and their affiliates. Both lawmakers expressed concern about risks posed by Brexit and profits of large banks. Arguing against any tailoring of margin requirements, Waters and Brown wrote: “These actions, here and abroad, will result in a reduced amount of funds held by U.S. banks and their foreign affiliates to safeguard taxpayers from another financial crisis where they, not the banks, will be left to foot the bill. Expanding the inter-affiliate swap exemption to all transactions would drain even more resources from insured depository institutions and increase the risk of a future taxpayer bailout still further.”
SEC & Securities
SEC Investor Advisory Committee Holds Meeting
On 25 July, the SEC’s Investor Advisory Committee held a meeting in which the participants discussed: (i) the SEC approach to regulation in areas with limited competition; (ii) trends in investment research and the impact of MiFID II; and (iii) the proxy process.
o Regulation in Areas with Limited Competition: The participants discussed, among other things: (i) regulatory barriers to entry for credit rating agencies; (ii) the impact of competition between property exchange markets and the dissemination of market data between firms; (iii) antitrust considerations for the market; (iv) market fragmentation; and (v) fixed costs of data and the adequacy of available data.
o Investment Research: The participants approved for SEC staff consideration an Investor Advisory Committee’s Market Structure Subcommittee recommendation that “consumers of [investment trading and research] regardless of where they are located be able to choose whether to purchase [investment trading and research] bundled or unbundled from trading” and protecting investors based on three key principles: (i) “prioritiz[ing] investor protection, investor choice (as it relates to Research payments), transparency, competitiveness, and cost”; (ii) “consider[ing] the interests of all investors in relation to Research, including, but not limited to, retail investors, asset owners, asset managers, and mutual fund managers”; and (iii) “consider[ing] the integrity of the securities marketplace by taking into consideration market participants of all sizes and geographies.”
o The Proxy Process: The participants delayed the approval for SEC staff consideration certain recommendations from the Investor Advisory Committee’s Investor-as-Owner Subcommittee, due to the participants’ expressing concern that they did not have enough time to consider the recommendations. The recommendations are that the SEC should: (i) “require end-to-end vote confirmations to end-users of the proxy system”; (ii) “require all involved in the system to cooperate in reconciling vote-related information, on a regular schedule, including outside specific votes, to provide a basis for continuously uncovering and remediating flaws in the basic “plumbing” of the system”; (iii) “conduct studies on…investor views on anonymity and…share lending”; and (iv) “adopt its proposed “universal proxy” rule, with the modest changes that would be needed to address objections that have been raised to that proposal.”
SEC Fixed Income Market Structure Advisory Committee Holds Meeting
On 29 July, the SEC’s Fixed Income Market Structure Advisory Committee (“FIMSAC”) held a meeting. During the meeting, the participants discussed: (i) a draft recommendation for investor education regarding retail notes; (ii) a draft recommendation on certain principal transactions with advisory clients; (iii) updates from the technology and electronic trading subcommittee and ETFs and bond funds subcommittee; (iv) the content and timeliness of municipal issuer disclosures; and (v) credit ratings.
o SEC Chairman Jay Clayton delivered the opening remarks for the meeting. During his remarks, Clayton announced that the SEC has extended the FIMSAC’s charter for another year. Clayton also highlighted the topics the committee is focusing on, including: (i) “considering the regulatory framework for fixed income electronic trading platforms” and (ii) examining “issues related to a classification scheme for exchange-traded products.” Clayton also noted that the SEC staff have been “engaging with FINRA to evaluate the practice known as ‘pennying’ in the corporate bond market.”
o Investor Education Regarding Retail Notes: The participants approved for SEC staff consideration a recommendation from the FIMSAC’s Corporate Bond Transparency Subcommittee that the “SEC and FINRA educate retail investors on the uses, characteristics, and risks of retail notes,” particularly to “identify the embedded issuer call option and survivor put options that are typical in these notes along with other options that may have an impact on the pricing of these notes.” In addition, the recommendation states that “investors should be made aware of their lower secondary market liquidity compared to similar securities from the same issuer.” The recommendation argues that “these objectives might be accomplished through the issuance of an ‘Investor Bulletin’,” but “leaves the final form as well as content of the education to the discretion of the SEC and FINRA.”
o Principal Transactions with Advisory Clients: The participants approved for SEC staff consideration a recommendation from the FIMSAC’s Municipal Securities Transparency Subcommittee that “the SEC consider a rule that permits a broker-dealer to meet the requirements of section 206(3) of the Advisers Act when acting in a principal capacity to sell certain client bond positions within the normal liquidation process, by allowing dealers to submit a “blind bid” on a principal basis against its advisory clients.”
o Updates from the Technology and Electronic Trading Subcommittee: Subcommittee Chair Rick McVey stated that the subcommittee has been considering new recommendations regarding: (i) “trading in the corporate bond gray market”; (ii) “potential improvements to trade settlement to expand market participation in all-to-all trading”; and (iii) “potential ideas around modernization of the investment manager’s best-execution guidelines.” He added, however, that the subcommittee is still at the “early stages of brainstorming [these] areas of the fixed income market structure where we can recommend improvements” and that “none of the topics are very far along and none are close to a new recommendation.”
o Updates from the ETFs and Bond Funds Subcommittee: Subcommittee member Rachel Wilson stated that the subcommittee identified two potential recommendations for the FIMSAC to consider, including: (i) identifying potential market-structure improvements that would reduce “step-away risk,” which is the risk that authorized participants cease their arbitrage activities during a stressed market that could cause a potential price dislocation and significant withdrawal of liquidity, and (ii) examining the impact of bond index construction methodologies for bond portfolios.
SEC Commissioner Peirce Delivers Speech on Opportunities for Cross Border Cooperation in Regulation of Digital Assets
On 30 July, SEC Commissioner Hester Peirce delivered a speech before the SUSS Convergence Forum: Inclusive Blockchain, Finance, and Emerging Technologies in Singapore. Peirce spoke about opportunities for cross border cooperation in regulation of digital assets. She began by highlighting some of the SEC’s concerns regarding cross-border regulation of digital assets, stating that such concerns “in many ways mirror concerns they have more generally in regulating cross-border market activity” Those concerns include: (i) “fear that we will not be able to examine foreign entities registered to operate in our markets”; (ii) the possibility that “our ability to enforce domestic rules will be stymied by our inability to regulate outside our borders”; (iii) “whether the application of our regulatory framework matches investor expectations”; and (iv) “understanding which assets will be available to meet domestic obligations if a foreign entity fails and what rules will govern the wind-down of the institution and protect any affected investors.” Peirce then noted that the “cross-border regulatory concerns in crypto track these standard concerns, but are magnified for several reasons,” including: (i) “countries all over the world are still in the early stages of determining how and whether to regulate crypto”; (ii) “much of the allure of cryptocurrency is the ability to join people from all across the world in common enterprises, which makes pinning down a domicile for these enterprises difficult”; and (iii) “the precise nature—currency, commodity, security, derivative—of many of the assets at issue is difficult to determine.” Turning to international cooperation, Peirce then argued that “[i]nternational communication and internationalization of markets need not lead to the internationalization of our regulations” and that the U.S. regulators “can look to our fellow regulators for shared consideration of difficult issues and coordination, but not for regulatory directive.” Finally, in reference to Singapore’s approach not to consider every token as a securities offering, Peirce indicated her support for the “creation of a non-exclusive safe harbor for the offer and sale of certain tokens.” She stated that “if a token network were to become sufficiently decentralized, tokens that were issued as securities might then become non-securities ‘utility’ tokens.” Additionally, she added that “[a] token offering made in reliance on the safe harbor would have to comply with certain requirements—for example, providing clear disclosure of the assets’ functionality” and “could be time-limited to guard against reliance on the safe harbor by projects without a workable plan to build operational networks.”
CFTC & Derivatives
CFTC Chairman Tarbert Discusses Priorities in Op-Ed
On 29 July, Commodity Futures Trading Commission (“CFTC”) Chairman Heath Tarbert wrote an op-ed for FoxBusiness.com, in which Tarbert laid out his priorities as the new chairman. He focused on two sets of issues: “resolving unfinished business and preparing for the unwritten future.” Regarding unfinished business, he wrote that the CFTC “must issue long-awaited rules to limit derivatives positions that help unscrupulous traders corner commodity markets.” Concerning the unwritten future, Tarbert discussed Brexit, the “rise of digital currencies that has created a new asset class,” and emerging threats such as cyber risks.
CFTC Commissioner Berkovitz Delivers Remarks Regarding the Beef Industry
On 31 July, CFTC Commissioner Dan Berkovitz delivered remarks before the National Cattlemen’s Beef Association in Denver, Colorado. Berkowitz opened by saying: “Futures and options are important hedging and price discovery tools for cattlemen and others in the beef industry. One of the fundamental purposes of the CFTC is to ensure that trading in futures and options contracts for commodities such as cattle is fair, efficient, and effective for commercial end-users. Berkovitz then touched on a number of diverse topics, including: (i) the “unique challenges” posed by live and feeder cattle markets “for standardizing futures contracts and exchange trading”; (ii) the negative consequences of the concentration of futures and option clearing in the ten largest futures commission merchants; and (iii) the CFTC’s “aggressive enforcement activities against spoofing” (i.e., bidding or offering with the intent to cancel the bid or offer before execution).
CFTC’s DMO Extends Time-Limited No-Action Relief from Certain Position Aggregation Requirements
On 1 August, the CFTC’s Division of Market Oversight (“DMO”) announced that it “has issued a no-action letter extending, until August 12, 2022, the relief provided in CFTC Letter 17-37, which would have expired on August 12, 2019.” The extended no-action letter will continue to “provide relief to market participants from certain position aggregation requirements in CFTC Regulation 150.4,” including by (i) “[r]evising the notice filing requirements”; (ii) revising certain definitional conditions for purposes of complying with the aggregation requirements; and (iii) “[l]imiting the aggregation requirements for ‘substantially identical trading strategies’ to circumstances where positions in more than one account or pool are held in order to willfully attempt to circumvent applicable position limits.”
CFTC Chairman Tarbert Assumes Sponsorship of CFTC’s Agricultural Advisory Committee
On 1 August, the CFTC announced that Chairman Tarbert will sponsor the CFTC’s Agricultural Committee, which “was created in 1985 to advise the Commission on issues involving the trading of agricultural commodity futures and options and facilitate communications between the CFTC, the agricultural community, and agriculture-related organizations.”
CFTC Releases New Episode of CFTC Talks Regarding Effects of Capital Rules
On 2 August, the CFTC released a new episode of CFTC Talks that “looks at the effect bank capital rules have had on the competitive landscape of derivatives clearing.” The episode (i) examines “effects of the Basel III capital and liquidity requirements across different asset classes and different market participants” and (ii) presents “evidence [that] suggests the leverage ratio requirement has pushed derivative clearing activities to less constrained institutions and market segments.”
CFTC Executive Announcements
On 30 July, CFTC Chairman Tarbert announced the appointment of Malcolm Clark Hutchison III to serve as Director of the Division of Clearing and Risk. In that role, Clark “will be responsible for the CFTC’s supervision of derivatives clearinghouses and their members, including oversight of clearing processes through risk assessment and surveillance.”
On 2 August, the CFTC announced that Daniel Corfine, the agency’s first Chief Innovation Officer and Director of LabCFTC, will depart in mid-August and return to the private sector.
FDIC Publishes 2019 Risk Review Report
On 30 July, the FDIC published its 2019 Risk Review. The report is published annually and “highlight[s] emerging risks and exposures in the banking system.” The 2019 report: (i) provides “a summary of conditions in the U.S. economy, financial markets, and banking industry” and (ii) “presents key risks to banks in two broad categories: credit risk and market risk.” The credit risk areas discussed include agriculture, commercial real estate, energy, housing, leveraged lending and corporate debt, and nonbank lending. With regards to a summary of the U.S. economy and financial marks, the report states: (i) “forecasts suggest U.S. economic growth will slow in 2019 from recent highs”; (ii) “[f]inancial markets reflected expectations for slower economic growth, and volatility returned to financial markets in 2018 and early 2019”; (iii) “FDIC-insured institutions performed well in 2018”; and (iv) “[c]onsolidation within the banking industry accelerated in 2018,” although “[c]ommunity banks continue to report lower consolidation rates than noncommunity banks.” With regards to interest rate risk and deposit competition, the report notes that “consumer preferences have shifted toward interest-bearing deposits, which are becoming increasingly expensive for both community and noncommunity banks,” which could lead to issues as deposit competition increases.” With regards to liquidity risk, the report notes that: (i) “[s]hort-term liquidity at smaller banks has declined in recent years, potentially reducing these institutions’ ability to manage a future downturn”; and (ii) “[a] turn in the credit cycle could be detrimental to institutions with low levels of liquidity or high levels of wholesale funding, particularly if a sale of securities is required to meet liquidity demands or if access to certain types of funding is limited.” The FDIC indicated that it intends to publish its next Risk Review in the spring of 2020.
OCC Issues Bulletins Regarding Banking Requests under the CRA
On 31 July, the OCC issued two bulletins regarding bank requests under the Community Reinvestment Act (“CRA”): (i) a bulletin “to inform national banks, federal savings associations, and federal branches of foreign banking organizations (collectively, banks) about current guidelines for requesting approval to be evaluated under the [CRA] using the strategic plan option or to request approval to amend an approved CRA strategic plan”; and (ii) a bulletin “to inform national banks, federal savings associations, and federal branches of foreign banking organizations … subject to the [CRA] about guidelines for requesting a designation as a wholesale or limited purpose bank for CRA purposes or requesting confirmation of its exemption as a special purpose bank under CRA regulations.” These guidelines summarize the process for addressing bank requests and cover: (i) “information that a bank should provide to substantiate its request”; (ii) “instructions on how to submit requests”; and (iii) “the OCC’s review and approval processes, as applicable.”
OCC Consolidates Supervision Support Functions, Announces New Units
On 31 July, the OCC announced the “realignment of approximately 150 staff members to create two new units, consolidating bank supervision support, risk analysis, and oversight of national trust banks and significant service providers.” The two new units that will be created are: (i) Supervision System and Analytical Support, which will include personnel from “supervisory information system teams, data management, business intelligence, risk analysis, and supervision risk management staff from other OCC supervisory and policy units”; and (ii) Systemic Risk Identification Support and Specialty Supervision, which will include personnel from “Large Bank Supervision and Midsize Bank Supervision as well as teams responsible for the supervision of trust companies from the Northeastern District National Trust Banks team and significant service providers from Bank Supervision Policy.” The personnel changes will take effect on 1 October 2019.
Fed Issues FOMC Statement
On 31 July, the Fed issued a statement of its Federal Open Market Committee’s (“FOMC”) decisions regarding monetary policy implementation. In the statement, the FOMC said that, “in light of the implications of global developments for the economic outlook as well as muted inflation pressures,” it has decided to lower the target range for the federal funds rate from 2-1/4 to 2-1/2 percent to 2 to 2-1/4 percent. In addition, the Fed voted unanimously to lower the interest rate paid on required and excess reserve balances from 2.35 to 2.10 percent, effective August 1, 2019. Lastly, the Fed unanimously voted to approve a quarter percentage point decrease in the primary credit rate from 3.00 to 2.75 percent, effective August 1, 2019.
CFPB Reopens Comment Period for Proposed Rulemaking on Home Mortgage Disclosure
On 31 July, the Consumer Financial Protection Bureau (“CFPB”) announced the reopening of the comment period for certain aspects of its May 2019 Advance Notice of Proposed Rulemaking (“ANPR”) related to Regulation C, which implements the Home Mortgage Disclosure Act. The ANPR “proposed amendments to Regulation C relating to the coverage thresholds for reporting data on closed-end mortgage loans and open-end lines of credit and partial exemptions under the Home Mortgage Disclosure Act (HMDA).” The ANPR’s original comment period ended on 12 June 2019; the reopened comment period will end on 15 October 2019.
CFPB Extends Comment Period for Debt Collection Proposal
On 2 August, the CFPB announced that it has extended, until 18 September 2019, the comment period on its May 2019 Notice of Proposed Rulemaking implementing the Fair Debt Collection Practices Act. According to the CFPB’s press release, “The proposal would provide consumers with clear protections against harassment by debt collectors and straightforward options to address or dispute debts.”
o August 5: Comments are due on the CFTC’s proposed rule on foreign futures and options transactions.
o August 13: The SEC’s Small Business Capital Formation Advisory Committee will hold a public meeting, the agenda for which is yet to be finalized.
o August 14: The SEC will host the 38th Annual Government-Business Forum on Small Business Capital Formation.