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Financial Industry Regulation Update – March 27, 2015

March 30, 2015

Author: Jenny E. Cieplak.

Last week, the House began the process of CFTC reauthorization, with a House Agriculture subcommittee holding hearings with testimony from CME, the NFA and various other market participants. The subcommittee members seem intent on presenting a bill very similar to last year’s HR 4413, which passed the House but was not taken up by the Senate. Given changes in Senate composition the bill seems more likely to be considered by both houses of Congress this year. At the hearings, witnesses focused on the costs of complying with new regulations, including reporting and the proposed margin and position limits rules, and the burden imposed by regulatory uncertainty. Subcommittee members were particularly focused on compliance costs and whether these costs were in line with the benefits provided by new regulations.

Witnesses mentioned a number of potential steps the CFTC should take, including expanding the definition of “bona fide hedge” in the position limits rules and delaying real-time reporting for swaps in thinly-traded markets so the counterparties cannot be identified. Witnesses also suggested tweaking the CFTC’s rulemaking process to allow for industry roundtables and open meetings before regulations are proposed, rather than waiting until the CFTC has already formulated its positions.

Cross-border harmonization was also stressed in both hearings. Senate Agriculture Chairman Pat Roberts (R.) separately wrote to Treasury Secretary Lew, requesting that the Secretary assist in solving the impasse between U.S. and European regulators over clearinghouse rules before the EU rules go into effect in June. It’s not clear that Secretary Lew will have any influence over this process, of course, as it is up to the CFTC and ESMA to harmonize their rules.

However, lawmakers are hearing ever greater pressure from their constituents over cross-border issues. CME Executive Chairman Terry Duffy even suggested on Wednesday’s hearing that the US should restrict European clearinghouses from American markets until the issue is resolved. CFTC Commissioner Bowen sounded a similar theme regarding regulatory uncertainty in her remarks before the 17th Annual OpRisk North America conference. Ms. Bowen also make several specific points about matters that should be covered in the risk management programs of swap dealers and MSPs. The first such point was that such programs should cover systemic risk, “the risk of your products to financial crises and major geopolitical disruptions.” Ms. Bowen also noted that risk management programs should include both the specific technology used to address various risks and the manner in which staff will address deficiencies.

It is safe to assume that any CFTC examination will look closely at risk management programs and that Ms. Bowen’s remarks should be taken into account in preparing such programs. Similar themes may be sounded in next week’s Market Risk Advisory Committee meeting, to be held on April 2. In particular, the MRAC may address CME’s suggestion that it may begin offering sponsored principal clearing, which would allow bank customers to hold margin for their trades in their own name (rather than under the bank’s name, which would require capital charges under Basel III).

Meanwhile, the SEC has proposed new rules that would require FINRA registration by high-frequency traders. The proposed regulation would narrow the “floor trader” exemption currently available to broker-dealers if they are a member of a national securities exchange, carry no customer accounts, and have annual gross income of no more than $1,000 that is derived from securities transactions effected other than (i) on a national securities exchange of which they are a member, or (ii) proprietary trading conducted with or through another broker-dealer.

The SEC also adopted long-awaited final rules implementing “Regulation A+,” designed to transform Regulation A, from a seldom-used, high-effort exemption from the registration requirements of the Securities Act of 1933 to a much more useful capital-raising tool for offerings up to $50 million. Our initial client alert regarding this new regulation can be found here, and a more detailed analysis will follow.
Jenny E. Cieplak
Partner – Washington, D.C.
Phone: +1 202.624.2542