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Financial Industry Regulation Update – April 17, 2015

April 17, 2015

Author: Jenny E. Cieplak.

On Tuesday, CFTC Commissioner Wetjen outlined his regulatory agenda for the next year in testimony before the House Agriculture Subcommittee on Commodity Exchanges, Energy and Credit. Commissioner Wetjen identified three key rulemakings before the CFTC – Margin for Uncleared Swaps, Capital Requirements, and Position Limits. He also addressed the issue of customer funds held by FCMs, noting that because bankruptcy law requires that an FCM’s customer funds be shared ratably among customers in the event of an FCM bankruptcy, the CFTC’s ability to require segregation of individual customer funds is limited.

The Commissioner suggested that Congress amend the bankruptcy code to permit greater flexibility for the protection of customer funds, noting that customers may currently believe they can get better protection in the OTC market which allows them to require segregation of their funds.

The Commissioner’s testimony also suggested several initiatives that would promote SEF trading of swaps, including CFTC action to end the practice of name give-ups, making permanent the temporary relief currently in place for package trades and block trades, and allowing error trades to be corrected and resubmitted for clearing. Commissioner Wetjen also suggested that Congress should take action to relieve some of the regulatory burden on SEFs by reducing the one-year capital requirement, since SEFs do not hold customer funds and are not party to trades.

Commissioner Wetjen also addressed cross-border issues, suggesting that the CFTC clarify its staff advisory that would apply transaction-level Dodd-Frank requirements to a swap between a non-US swap dealer and its non-US client, where the personnel arranging the trade were located in the US, and that if the no-action relief regarding this advisory is allowed to expire, that an appropriate implementation period be implemented. CFTC Commissioner Bowen also testified before the House Agriculture Subcommittee on Commodity Exchanges, Energy and Credit.

A considerable portion of Commissioner Bowen’s testimony was devoted to suggestions for new funding mechanisms for the CFTC, including registration fees for market participants and increased enforcement penalties. Commissioner Bowen also made reference to the need for increased regulatory scrutiny of the retail FX markets, noting that retail FX transactions are actually subject to a lower level of regulation than the rest of the swaps market, and reminding listeners of the recent market losses following the Swiss National Bank’s January decision to remove the Euro-based cap on the Swiss franc.

CFTC Commissioner Giancarlo also provided testimony, in which he reiterated many of the points discussed in his previous white paper on regulatory reform. Commissioner Giancarlo outlined a proposal for a four-pronged regulatory framework, based on CFTC oversight of the entire swaps market, regulatory cohesiveness and similar treatment of all swaps, whether or not traded on an exchange, flexibility and the ability to choose among the broadest possible array of execution methods, and enhancing professionalism in the swaps markets through education and examinations of swaps market personnel.

Last Wednesday, the Global Meeting of Foreign Exchange Committees released the minutes of its annual meeting. A number of issues of interest were discussed at the meeting, including the impact of high-frequency trading on the global FX market in general, and on the volatility in markets following the removal of the Euro-based cap on the Swiss franc (an issue of great concern to a number of regulators). The Committees noted that the prevalence of algorithmic and high-frequency trading on electronic platforms could have contributed to the initial sharp price action in the franc, although they did note that high-frequency trading could have enabled the market to stabilize faster than otherwise expected. The Committees are composed of central bankers and representatives of the private sector, including representatives of the New York Fed, the European Central Bank, the Bank of England.

The SEC has proposed new rules aimed at closer regulatory scrutiny of high-frequency equities traders, but the rules apply only to market participants already registered as broker-dealers. Spot FX regulation is generally limited to regulation of retail trades, but FX derivatives are regulated by the CFTC. The CFTC does not currently require registration of high-frequency traders as such, but in practice many high-frequency traders in FX derivatives will be required to register as swap dealers or major swap participants.
Jenny E. Cieplak
Partner – Washington, D.C.
Phone: +1 202.624.2542