Sunday, July 28, 2013

G-20 Finance Ministers Reaffirm Call for Consistent Cross-Border Derivatives Regulation in Wake of European Commission-CFTC Agreement

In their final communique from their recent meeting, the G-20 Finance Ministers noted the continued progress in implementing OTC derivatives reforms, but said that work remains to ensure greater consistency in cross-border regulatory standards. The Finance Ministers, including U.S. Treasury Secretary Jacob Lew, are committed to rapidly completing the remaining legislative frameworks and regulations for these reforms. In particular, the Ministers praised the recent European Commission-CFTC. Agreement on cross-border issues related to OTC derivatives reforms as a major constructive step forward, which paves the way for resolving remaining conflicts, inconsistencies, gaps and duplicative requirements globally. Further steps remain needed, and the Finance Ministers have asked key regulators to report by the September Summit of the G-20 Leaders on how they have resolved these cross-border issues. In this context, the Finance Ministers agree that jurisdictions and regulators should be able to defer to each other when it is justified by the quality of their respective regulations and enforcement regimes, based on essentially identically outcomes, in a non-discriminatory way, paying due respect to home country regulation regimes. This position essentially endorses the CFTC’s substituted compliance regime and the E.U.’s equivalence regime.

The G-20 also look forward to further Financial Stability Board policy recommendations for the oversight and regulation of the shadow banking system by the Leaders’ Summit and will work towards their timely implementation. They also reiterated their call on the IASB and FASB to finalize by the end of 2013 their work on key outstanding projects for achieving convergence on a single set of high-quality accounting standards.

The Finance Ministers also look forward to the FSB progress report on both national authorities’ and standard setting bodies’ steps to reduce reliance on credit rating agencies ratings for the St PetersburgG-20 Leaders Summit. They welcome the completion of IOSCO’s Principles for Financial Benchmarks and the establishment of the FSB’s Official Sector Steering Group to coordinate work on the necessary reforms of interest rate benchmarks and guide the work of a Market Participants Group.

House Appropriations Committee Approves Legislation Funding SEC and Ensuring Privacy Protection for E-Mails

The House Appropriations Committee has approved legislation for financial services agencies recommending an appropriation of $1,371,000,000 for the SEC for fiscal year 2014, which is $303,000,000 less than the request. The Committee designates not less than $7,092,000 for the Office of Inspector General and $44,353,000 for the Division of Economic and Risk Analysis. An amendment introduced by Rep. Kevin Yoder (R-KN) that would prohibit funding for the SEC to require the disclosure of political activity on company filings was adopted by a vote of 28-18.

Another amendment offered by Rep. Yoder, and unanimously adopted by the Appropriations Committee, prohibits funding to require the disclosure of private e-mail information by internet service providers without a criminal warrant. The Yoder Amendment affirms that the IRS and SEC and other agencies under the jurisdiction of the Financial Services and General Government appropriations bill must extend the same Fourth Amendment privacy protections to e-mail and other electronic communications as they do to hard mail and other private documents. Rep. Yoder said that the amendment means that government agencies must obtain a search warrant to obtain and view e-mails from third-party service providers.

According to Rep. Yoder, the IRS, SEC, and other government agencies have stated that there is no expectation of privacy with e-mail, a position with which he completely disagrees. By passing this amendment, he noted, the Appropriations Committee is taking a critical step towards Fourth Amendment protections in mail and private e-mails. While communication methods have dramatically changed over the past twenty years, he observed, the electronic communications laws have not kept pace.Congressman Yoder’s Email Privacy Act continues to gain significant and broad bipartisan support in the House. H.R. 1852 currently has 120 co-sponsors; including 90 Republicans and 30 Democrats.

In the Committee Report accompanying the legislation, the Committee said it was supportive of the SEC’s prioritization of robust and effective information technology systems within the Commission. The SEC has indicated the use of the Dodd-Frank mandatory Reserve Fund to support the Commission’s IT initiatives. This fund is not overseen by Congress and it is left to the discretion of the Commission as to its use. The Committee believes emergency reserve funds should be used for natural disaster emergencies and other crises, not discretionary priorities within a Federal agency. While the Committee does not support the use of the Reserve Fund, an increase to IT funding is provided through the Commission’s overall appropriation. The Committee’s recommended funding level for the SEC increases the overall funding level by $50,000,000 specifically to support IT funding priorities. The Committee has restricted funds from the Reserve Fund from being used in Section 618.

Economic Analysis in Rulemaking. Since 2001, the SEC’s budget has increased almost 300 percent. Based on the increases Congress has provided, the Commission should be able to provide for comprehensive economic analysis before promulgating rules that affect the capital markets. It appears that thorough economic analysis has not always been done before Commission rulemakings, said the Committee Report, and courts have overturned SEC rules due to insufficient economic examination. As the agency in charge of overseeing capital markets, economic analysis should be a cornerstone to all agency rulemaking. The Committee’s recommended funding level for the SEC fully funds the Division of Economic and Risk Analysis to support increased hiring of economists and economic analysis within the Commission to enhance the understanding of the economic impacts of SEC rulemakings. The Committee expects the Commission to expand this division and prioritize nonpartisan economic analysis as a fundamental part of the Commission’s rulemaking process.

Cross Border Derivatives. The Committee believes that the rules regarding cross border derivatives should be promulgated jointly by the SEC and the Commodity Futures Trading Commission (CFTC). The current lack of regulatory coordination between regulators does not provide a cohesive landscape for investors and foreign regulators. The Committee strongly encourages the SEC and CFTC to work swiftly toward rules that mirror one another and provide certainty to the financial markets.

Hong Kong Authorities Reach Agreement with RBS on Lehman Brothers Equity Notes

The Securities and Futures Commission and the Hong Kong Monetary Authority have announced an agreement with The Royal Bank of Scotland N.V. (RBS), formerly known as ABN AMRO Bank N.V. in relation to the sale of Lehman Brothers-related equity-linked notes to retail clients between July 2007 and May 2008. RBS has agreed, without admitting any liability, to make a repurchase offer to all eligible customers holding outstanding equity-linked notes sold by the bank at 100% of the principal value of each eligible customer’s investment in the note. This resolution provides them an opportunity to reverse their purchase of the outstanding notes. The SFC estimates about 540 customers are eligible for the repurchase offer under this resolution which, if accepted by all, will lead to payments of approximately $513 million. The repurchase offer will not be offered to professional investors. The SFC’s investigation into the handling of professional investors by RBS in respect to the notes is continuing.

The SFC’s Chief Executive Officer Ashley Alder cautioned that the problems caused by the errors in ABN Amro’s processes should send a warning to all intermediaries who seek to automate suitability processes with matching systems. Mr. Alder emphasized that an automated process cannot replace governance disciplines and professional judgment in assessing whether an investment advice or recommendation is reasonably suitable for the customer.

The eligible customers are retail customers holding outstanding Lehman equity-linked notes who were assessed to have a risk tolerance level that was more conservative than the risk rating assigned to the notes purchased by the customer. The risk profiling process in issue in this case was developed by ABN Amro prior to RBS’ acquisition of ABN Amro’s retail and commercial banking business.

RBS will also make top-up payments to retail customers with whom RBS has entered into settlement agreements in respect of their holding of outstanding notes but would otherwise have been eligible to receive a repurchase offer to ensure these customers are treated in the same way as other customers participating in the repurchase scheme.

In view of the repurchase scheme, the SFC will not impose disciplinary sanctions against the bank and its current or former officers or employees in relation to the sale of the notes to retail customers, save for any acts of dishonesty, fraud, deception or conduct that is criminal in nature. Similarly, the HKMA informed the bank that it does not intend to take any enforcement action against their executive officers and relevant individuals in connection with the sale of the notes to customers who have accepted the repurchase offers or the top-up payments under the repurchase scheme, except for any acts of dishonesty, fraud, deception or conduct that is criminal in nature.

ESMA proposes guidance on accounting and auditing enforcement actions

The European Securities and Market Authority (ESMA) has proposed guidance on enforcement actions involving the filing of audited financial statements and information in an effort to achieve consistency throughout the European Union. ESMA is of the view that in order to achieve a proper and rigorous enforcement regime to underpin investors’ confidence in financial markets and to avoid regulatory arbitrage by issuers in the EU Single Market, there is a need for a common European approach to the requirements in the Transparency Directive on the enforcement of audited financial information.

It is axiomatic, and ESMA acknowledges, that the issuance of accounting standards and the interpretation of their application is reserved to standard setters such as the IASB.. Therefore, ESMA and enforcers do not issue any general IFRS application guidance to issuers. Nevertheless, as part of their enforcement activities, enforcement authorities have to apply their judgment in order to determine whether accounting practices are considered as being within the accepted range as permitted by the relevant reporting frameworks.

Reporting by ESMA of any material controversial accounting issues, as well as ambiguities and any lack of specific guidance, discovered during the enforcement process in cases of IFRS application to the bodies responsible for standard setting and interpretation (IASB and IFRS IC), is a necessary step in ensuring consistent application and enforcement. This is also the case for any other issues identified which create enforceability constraints during the enforcement process.

Moreover, Recital 16 of the IFRS Regulation on the application of international accounting standards provides that: a proper and rigorous enforcement regime is key to underpinning investor confidence in financial markets. ESMA reminded that Member States are required to take appropriate measures to ensure compliance with international accounting standards.

ESMA has revised the objective of enforcement in the earlier CESR guidance to reflect the importance of compliance with the relevant financial reporting standards and transparency of financial information. These elements contribute to market confidence and investor protection. The concept of enforcement has been extended in order to include, in addition to the enforcers’ review of the financial information, any other actions which might contribute to enforcement such as for example issuing alerts.

The purpose of enforcement on issues relating to financial information, as defined under the Transparency Directive, is to protect investors and promote market confidence by contributing to the transparency of financial information relevant to the investors’ decision-making process The provision of full and consistent information concerning issuers of securities promotes the protection of investors. Moreover, such information provides an effective mean of increasing confidence in securities and contributes to the proper functioning and development of securities markets. The challenge for a competent authority is to make sure that no prospectuses with obvious inconsistencies is approved and to develop appropriate procedures for taking into account the risk related to an issuer.

An important element in the enforcement process is the level of materiality. Provided that enforcement is aimed at taking actions where departures from the reporting framework are detected, noted ESMA, materiality should necessarily be defined consistently both for reporting purposes and for enforcement purposes. For example, where financial statements are prepared in accordance with IFRS, reference should be made to the definition of materiality provided under IFRS.

As material misstatements could, by definition, have an impact on investor and other users’ decisions, it is important that investors are not only informed that there is a misstatement, but are also provided with the corrected information on a timely basis.

Saturday, July 27, 2013

CFTC Finalizes Guidance on Cross-Border Derivatives Regulation, Embodying Substituted Compliance

Against the backdrop of a recently agreed upon Path Forward with the European Commission on cross-border derivatives regulation, the CFTC voted 3-1 to adopt final guidance to provide greater legal certainty and clarity to U.S. and non-U.S. market participants regarding their obligations under the Commodity Exchange Act with respect to their cross-border swaps activities. The guidance embodies the concept of substituted compliance, under which the CFTC would defer to comparable and comprehensive foreign derivatives regulatory regimes. The CFTC also approved by a 3-1 vote an exemptive order giving market participants time to phase in to this new market reality by providing temporary conditional relief from certain swap provisions of the Dodd-Frank Act to non-U.S. swap dealers as well as foreign branches of U.S. swap dealers.

The Dodd-Frank Act amended the Commodity Exchange Act to establish comprehensive regulation of swaps by the CFTC. Section 722(d) of the Dodd-Frank Act amended the CEA by adding section 2(i), which provides that the swaps provisions of the CEA apply to cross-border activities having a direct and significant connection with activities in, or effect on, commerce of the United States or when they contravene Commission rules or regulations as are necessary or appropriate to prevent evasion of the swaps provisions of the CEA enacted under Title VII of the Dodd-Frank Act. The guidance sets forth the general policy of the Commission in interpreting how section 2(i) of the CEA provides for the application of the swaps provisions of the CEA and Commission regulations to cross-border activities.

Under the doctrine of substituted compliance, which is at the heart of the guidance, and consistent with CEA section 2(i) and comity principles, the Commission’s policy is that a non-U.S. swap dealer or major swap participant may comply with a foreign jurisdiction’s law and regulations in lieu of compliance with the attendant CEA and Commission regulations. In issuing comparability determinations, which will be based on whether a foreign regime’s requirements are comparable to and as comprehensive as the corollary areas of regulatory obligations encompassed by the Entity and Transaction-Level Requirements (see below), the Commission will rely upon an outcomes-based approach to determine whether foreign requirements achieve the same regulatory objectives as the Dodd-Frank Act. The foreign regulations must be comparable and comprehensive but not necessarily identical.

In their presentation, CFTC staff explained that the substituted compliance regime set forth in the guidance means that if the Commission issues a comparability determination for a given entity or transaction level requirement the Commission generally would permit an applicant to substitute compliance with the requirements of the relevant home jurisdictions law and regulations or in the case of foreign branches of U.S. swap dealers the foreign location of the branch in lieu of compliance with the corresponding requirement under the Commodity Exchange Act and CFTC regulations. The guidance broadly describes the process and the factors that it would consider in in making this comparability assessment. The staff emphasized two points in connection with substituted compliance. First, comparable and comprehensive does not mean that the CFTC would look for identical regulations abroad.

Rather, the Commission would take into account all relevant factors including the scope and objectives of the relevant regulatory requirements and the comprehensiveness of the foreign regulators compliance program when making the assessment. Second, this assessment does not entail a rule by rule analysis but rather the Commission would make this assessment on a category by category basis.

Commissioner Scott O’Malia noted that the substituted compliance regime is an outcomes-based regime. He is concerned that there be a process in place to make substituted compliance determinations that involves the CFTC Commissioners, CFTC staff and the non-US jurisdiction seeking a substituted compliance determination. He urged the staff to come up with a process to continuously update the Commissioners on what they are working on and where they are in terms of the submissions from foreign regulatory regimes. There will probably be some very disappointed regulators that believe they are equivalent and receive a different outcome than they expect, noted the Commissioner, so he wants a transparent process on substituted compliance that lets foreign jurisdictions have an idea on substituted compliance at the 5th hour rather than the 11th hour.

Chairman Gary Gensler agreed on the need for regular updates, Commission briefings or Commissioner briefings. Noting that the Commission already has six submissions on substituted compliance from non-US jurisdictions, the CFTC Chair asked the staff to develop a process within the next two weeks that's a real process to keep the Commission updated on the six jurisdictions.

Commissioner O’Malia also urged the staff, and the staff agreed to do so, to invite foreign regulators to participate in some sort of dialogue if they want to come defend their submissions on substituted compliance or talk about their submissions. This dialogue would be very helpful in order to gain an understanding of what non-US regulators are thinking and how they execute their own regulations and where they believe they are comparable.

The CFTC explained that the various Dodd-Frank Act swaps provisions applicable to swap dealers and MSPs can be conceptually separated into Entity-Level Requirements, which apply to a swap dealer or MSP firm as a whole, and Transaction-Level Requirements, which apply on a transaction-by-transaction basis. The Entity-Level Requirements under Title VII of the Dodd-Frank Act and the Commission’s regulations promulgated thereunder relate to: (i) capital adequacy; (ii) chief compliance officer; (iii) risk management; (iv) swap data recordkeeping; (v) swap data repository reporting (“SDR Reporting”); and (vi) physical commodity large swaps trader reporting (“Large Trader Reporting”).

The guidance divides these requirements into two categories. The first category of Entity-Level Requirements includes capital adequacy, chief compliance officer, risk management, and swap data recordkeeping under Commission regulations 23.201 and 23.203 (except certain aspects of swap data recordkeeping relating to complaints and sales materials) (“First Category”). The second category of Entity-Level Requirements includes SDR Reporting, certain aspects of swap data recordkeeping relating to complaints and marketing and sales materials under Commission regulations 23.201(b)(3) and 23.201(b)(4) and Large Trader Reporting (“Second Category”).

The Transaction-Level Requirements include: (i) required clearing and swap processing; (ii) margining (and segregation) for uncleared swaps; (iii) mandatory trade execution; (iv) swap trading relationship documentation; (v) portfolio reconciliation and compression; (vi) real-time public reporting; (vii) trade confirmation; (viii) daily trading records; and (ix) external business conduct standards. The guidance classifies all Transaction-Level Requirements except external business conduct standards as “Category A” Transaction-Level Requirements, and classifies external business conduct standards as “Category B” Transaction-Level Requirements.

Global Markets Advisory Committee. Concomitantly, the CFTC voted 4-0 to name Commissioner Bart Chilton as sponsor of the Global Markets Advisory Committee. At Chairman Gensler’s urging, Commissioner Chilton agreed to open a transparent process inviting foreign regulators, home country regulators, to participate in defending their regulatory regimes before the Commission makes a decision on substituted compliance. Commissioner Chilton added that substituted compliance is not something that the CFTC will look at one time and take a snapshot and call it quits, rather substituted compliance is an evolving and a morphing doctrine; and the Commissioner believes that the GMAC can play a really important role in that regard. In general these markets are changing so fast that the CFTC needs to think anew about them, said Commissioner Chilton, and involves the CFTC and the GMAC in what the Commissioner called an epic global endeavor.

Definition of U.S. Person. The definition of U.S. person, a foundational element of the guidance, is largely territorial-based. The definition would include collective investment vehicles, including hedge funds and commodity pools, that are directly or indirectly majority-owned by U.S. persons, or that have their principal place of business in the U.S., focusing principally on location of the investment managers, fund sponsors and promoters, and the sales and trading desk used by the fund. A non-U.S. person that is guaranteed by and an affiliate of a U.S. person is not included in the definition of U.S. person

CFTC staff said that the term U.S. person is a useful concept when considering the extent to which U.S. transactional level requirements should apply to swap transaction. The definition would include natural persons that are U.S. residents as well as corporations, business entities and funds that are organized in the United States or have their principle place of business here.

Exemptive Order. Under the Exemptive Order, market participants may continue to apply the swap dealer and MSP calculation provisions contained in the January Order from July 13, 2013 until 75 days after the Guidance is published in the Federal Register. Accordingly, during this time period, a non-U.S. person may exclude (from its swap dealer de minimis and its MSP threshold calculations) any swap where the counterparty is not a U.S. person, or any swap where the counterparty is a foreign branch of a U.S. person that is registered as a swap dealer.

Company’s Form 8-K Reveals Formation of IRS Working Group to Study What Constitutes Real Estate for REIT Purposes

In a Regulation FD Disclosure filed on Form 8-K, June 6, 2013, Equinix, Inc., a company planning conversion to a real estate investment trust (“REIT”) and seeking a private letter ruling from the Internal Revenue Service, revealed that the IRS recently informed the company that the Service has convened an internal working group to study what constitutes “real estate” for purposes of the REIT provisions of the Internal Revenue Code and that, pending the completion of the study, the IRS is unlikely to issue private letter rulings on what constitutes real estate for REIT purposes.

IRS Letter Ruling. The company said that its private letter ruling request has multiple components, and the conversion to a REIT will require favorable rulings from the IRS on numerous technical tax issues, including classification of the company’s data center assets as qualified real estate assets. Equinix filed its private letter ruling request with the IRS in the fourth quarter of 2012.

The company cannot predict when the IRS working group will complete its study or what the outcome of the study will be. However, the company continues to believe, based on both existing legal precedent and the fact that other data center companies currently operate as REITs, that its data center assets constitute real estate for REIT purposes.

While the company anticipates that the formation of the IRS working group to study this issue may delay receipt of its requested private letter ruling from the IRS, the company continues to move forward on its plan to convert to a REIT, including changing its method of depreciating data center assets for tax purposes, planning for legal restructuring and enterprise reporting system upgrades and ongoing engagement of appropriate REIT advisors. At this time, the company does not expect the potential delay in receiving a private letter ruling as a result of the new IRS working group will delay its plan to elect REIT status for the taxable year beginning January 1, 2015.

Senate Appropriations Committee approves legislation fully funding the SEC and CFTC

The full Senate Committee on Appropriations approved the fiscal year 2014 Financial Services and General Government bill fully funding the SEC and CFTC at the requested levels by a vote of 16-14. The measure will now be reported to the full Senate for its consideration. Senator Barbara A. Mikulski (D-Md.), Chair of the Appropriations Committee, said that the financial services bill important to protecting consumers from unfair practices and unsafe products. She noted that these agencies work to keep the financial markets honest and fair in order to ensure that investors are not victims of scams or schemes. They fight scammers aiming to defraud persons of their hard earned savings. The Appropriations Committee approved report language, authored by Senator Susan Collins (R-ME), which directs the Consumer Financial Protection Bureau to provide a full annual briefing to the relevant Appropriations subcommittee on the Bureau's finances and expenditures. The amendment was approved by the Committee with a voice vote.

The Committee noted that farmers and businesses that use the futures markets to manage risk, as well as pensions and endowments, rely on the CFTC to properly monitor the markets to guard against fraud, manipulation, or systemic risk. Bringing more transparency and accountability to the futures and derivatives markets is crucial. The bill provides $315 million for the CFTC. This funding level is $110 million above the fiscal year 2013 enacted level of $205 million. The Committee believes that these resources will ensure that needed staffing and sophisticated technology are in place to foster open, competitive, and financially sound futures and swaps markets.

With regard to SEC funding, the Committee noted that the strength of the economy and the soundness of the financial markets depend upon investor confidence in the financial disclosures and statements released by publicly traded companies for which SEC oversight is indispensable. The bill includes $1.674 billion to help the SEC fulfill its mandate to protect investors, maintain fair, honest, and efficient stock and securities markets, and promote capital formation. This funding level is $353 million above the fiscal year 2013 enacted level and is fully offset by fees collected on transactions.

Saturday, July 20, 2013

EU Implements Basel III with Capital Requirements Directive and Regulation

Capital Requirements Regulation, which among other things transposes Basel III into European law, is expected to be applied from 1 January 2014. The Regulation, CRR, is directly applicable, i.e. it does not have to be implemented. However, existing national legislation has to be adjusted for all competing provisions or for those provisions contrary to the Regulation. CRD IV, by contrast, has to be transposed into national law by an act of legislation.

The aim of the CRD IV package is to bring about a quantitative and especially qualitative enhancement in financial institutions’ capital adequacy and for the first time provide for liquidity requirements harmonized throughout the EU. Moreover, a Single Rule Book will be created under CRD IV and CRR. This harmonized legislation ensures a uniform legislative framework within the European Single Market and prevents regulatory arbitrage. The Member States nevertheless will have certain freedoms in the area of macro prudential or systemic risks so as to reflect national specificities, for example the relationship of the aggregate economy to the trend in lending. The CRD IV package applies to all deposit-taking credit institutions in the EU as well as to investment firms, but in some cases not in its entirety.

According to the German Federal Financial Supervisory Authority (BaFin), the legislation is directly applicable and for the most part is addressed to the financial institutions directly. The Regulation for the first time prescribes a procedure for calculating and reporting a leverage ratio on the basis of which the competent supervisory authorities can examine and assess a financial institution. From 2015, the financial institutions will also have to publish the leverage ratio. A harmonized EU-wide concept for the leverage ratio is to be determined by early 2018. Currently it is not foreseeable whether it will apply as a binding risk-dependent criterion alongside of the (then already applicable) risk-based minimum own funds requirements (Pillar I) or instead will be adopted as part of an institution’s Supervisory Review and Evaluation Process (SREP) (Pillar II).

The Regulation forms an essential part of the Single Rule Book: since it applies directly, it ensures that largely uniform rules will apply in the Member States in future. Apart from narrowly defined exceptions, there are no longer any options for national supervisory authorities. The few options remaining in the Regulation are limited in term.

The Directive, CRD IV, which still has to be implemented by the individual Member States, covers provisions addressed to the national supervisory authorities or requiring action on their part. Besides provisions on cooperation in supervisory matters, these notably include the qualitative provisions of Pillar II on the Internal Capital Adequacy Assessment Process (ICAAP) and the SREP.

Also covered are provisions on the authorization procedure, shareholder control as well as supervisory measures and sanctions. These have been harmonized under CRD IV. So far, the regime of measures and sanctions has varied considerably within the EU. In future, a uniform minimum set of tools will be available to the national supervisory authorities throughout the EU. The catalogue of fines has also been harmonized.

Governance rules have also been revised under CRD IV. The financial crisis revealed shortcomings in financial institutions’ internal risk control. The core element of the new provisions is a more rigorous supervision of risks by directors as well as management or supervisory boards, noted BaFin. Greater importance is also being attached to the corporate risk control function and sustainability of the business strategy. In addition, there will be more stringent requirements to be met in terms of the make-up and qualification of executive bodies as well as management or supervisory boards.

The Directive also provides for a cap on managers’ variable remuneration. Bonuses are not to exceed the fixed components of their remuneration, unless a firm’s general meeting gives its consent to that by way of qualified majority, in which case variable remuneration may be no more than two times the amount of the fixed remuneration. The European Banking Authority will develop qualitative and quantitative criteria for identifying the risk takers who are to be subject to this provision.

BaFin Chief Executive Director Raimund Röseler emphasized that managing risks responsibly is incumbent above all of the financial institutions and their controlling bodies, which is why corporate governance requirements are so important. He also noted that company supervisory boards in particular will have to do a better job than in the past when it comes to performing their controlling function. BaFin will be watching closely to see whether that actually happens, he said.

Senate Companion Bill Would Codify Dodd-Frank Derivatives End-User Exemption

Senators Mike Johanns (R-NE) and Jon Tester (D-MT.) are leading a bipartisan coalition of Senators in introducing a bill to codify the Dodd-Frank Act derivatives end-user exemption for non-financial commercial companies that use derivatives to manage their risk and insure against extreme price fluctuations for commodities critical to their business operations. Senator Mark Warner (D-VA), a key member of the Banking Committee, is co-sponsoring the bill, along with the Committee’s Ranking Member Senator Larry Crapo (R-ID). S. 888 is companion bill to H.R. 634, which was favorably reported out of the House Financial Services Committee by a 59-0 vote and is almost certainly headed for passage by the full House.

The Senate bill is identical to H.R. 634, and clarifies current law by making explicit that commercial end-users are not subject to costly margin requirements, consistent with Congress’ intent in Dodd-Frank. End-users are the final user of a good or product. Dodd-Frank legislative history indicates an exemption for non-financial end-users based on the low risks they pose to the financial system. Despite Congress’ intent, there has been a debate over how broadly the exemption would apply. While the CFTC and SEC previously issued a joint rule that would exempt end-users from margin, the Federal Reserve has issued regulations that would capture many end-users in their regulations.

IRS Delays FATCA Reporting Obligation Deadline by Six Months

In order to allow for a more orderly implementation of FATCA, Treasury and the IRS have postponed by six months the start of FATCA withholding, and made corresponding adjustments to various other time frames provided in the final regulations. IRS Notice 2013-43. A primary reason for extending the deadline was that certain elements of the phased timeline for the implementation of FATCA were presenting practical problems for both U.S. withholding agents and foreign financial institutions. In addition, while comments from foreign financial institutions overwhelmingly supported the development of intergovernmental agreements (IGAs) as a solution to the legal conflicts that might otherwise impede compliance with FATCA and as a more effective and efficient way to implement cross-border tax information reporting, some comments noted that, in the short term, continued uncertainty about whether an IGA will be in effect in a particular jurisdiction hinders the ability of foreign financial institutions and withholding agents to complete due diligence and other implementation procedures.

Withholding agents generally will be required to begin withholding on withholdable payments made after June 30, 2014, to payees that are foreign financial institutions with respect to obligations that are not grandfathered obligations, unless the payments can be reliably associated with documentation on which the withholding agent can rely to treat the payments as exempt from withholding.

Passed as part of the Hiring Incentives to Restore Employment Act (HIRE), FATCA creates a new reporting and taxing regime for foreign financial institutions with U.S. accountholders. FATCA adds a new Chapter 4 to the Internal Revenue Code, essentially requiring foreign financial institutions to identify their customers who are U.S. persons or U.S.-owned foreign entities and then report to the IRS on all payments to, or activity in the accounts of, those persons.

The Act broadly defines foreign financial institution to comprise not only foreign banks but also any foreign entity engaged primarily in the business of investing or trading in securities, partnership interests, commodities or any derivative interests therein. According to the Joint Committee on Taxation, investment vehicles such as hedge funds and private equity funds will fall within this definition. Firms meeting the definition must enter into agreements with the IRS and report information annually in order to avoid a new U.S. withholding tax.

According to IRS Notice 2013-43, the FATCA registration website is projected to be accessible to financial institutions on August 19, 2013. Other key dates for registration, however, will be extended by six months. Thus, after the FATCA registration website opens, a financial institution will be able to begin the process of registering by creating an account and inputting the required information for itself, for its branch operations, and, if it serves as a lead financial institution, for other members of its expanded affiliated group. All input information will be saved automatically in the registration system and associated with the financial institution’s account. For the period from the opening of the FATCA registration website through December 31, 2013, a financial institution will be able to access its account to modify or add registration information, including to indicate the appropriate registration status, as such status is established, for example, by the signing of an IGA.

Prior to January 1, 2014, however, any information entered into the system, even if submitted as final, will not be regarded as a final submission, but will merely be stored until the information is submitted as final on or after January 1, 2014. Thus, financial institutions can use the remainder of 2013 to get familiar with the registration process, to input preliminary information, and to refine that information. On or after January 1, 2014, each financial institution will be expected to finalize its registration information by logging into its account on the FATCA registration website, making any necessary additional changes, and submitting the information as final.

In order to allow for a more orderly implementation of FATCA, Treasury and the IRS have postponed by six months the start of FATCA withholding, and made corresponding adjustments to various other time frames provided in the final regulations. IRS Notice 2013-43. A primary reason for extending the deadline was that certain elements of the phased timeline for the implementation of FATCA were presenting practical problems for both U.S. withholding agents and foreign financial institutions. In addition, while comments from foreign financial institutions overwhelmingly supported the development of intergovernmental agreements (IGAs) as a solution to the legal conflicts that might otherwise impede compliance with FATCA and as a more effective and efficient way to implement cross-border tax information reporting, some comments noted that, in the short term, continued uncertainty about whether an IGA will be in effect in a particular jurisdiction hinders the ability of foreign financial institutions and withholding agents to complete due diligence and other implementation procedures.

Withholding agents generally will be required to begin withholding on withholdable payments made after June 30, 2014, to payees that are foreign financial institutions with respect to obligations that are not grandfathered obligations, unless the payments can be reliably associated with documentation on which the withholding agent can rely to treat the payments as exempt from withholding.

Passed as part of the Hiring Incentives to Restore Employment Act (HIRE), FATCA creates a new reporting and taxing regime for foreign financial institutions with U.S. accountholders. FATCA adds a new Chapter 4 to the Internal Revenue Code, essentially requiring foreign financial institutions to identify their customers who are U.S. persons or U.S.-owned foreign entities and then report to the IRS on all payments to, or activity in the accounts of, those persons.

The Act broadly defines foreign financial institution to comprise not only foreign banks but also any foreign entity engaged primarily in the business of investing or trading in securities, partnership interests, commodities or any derivative interests therein. According to the Joint Committee on Taxation, investment vehicles such as hedge funds and private equity funds will fall within this definition. Firms meeting the definition must enter into agreements with the IRS and report information annually in order to avoid a new U.S. withholding tax.

According to IRS Notice 2013-43, the FATCA registration website is projected to be accessible to financial institutions on August 19, 2013. Other key dates for registration, however, will be extended by six months. Thus, after the FATCA registration website opens, a financial institution will be able to begin the process of registering by creating an account and inputting the required information for itself, for its branch operations, and, if it serves as a lead financial institution, for other members of its expanded affiliated group. All input information will be saved automatically in the registration system and associated with the financial institution’s account. For the period from the opening of the FATCA registration website through December 31, 2013, a financial institution will be able to access its account to modify or add registration information, including to indicate the appropriate registration status, as such status is established, for example, by the signing of an IGA.

Prior to January 1, 2014, however, any information entered into the system, even if submitted as final, will not be regarded as a final submission, but will merely be stored until the information is submitted as final on or after January 1, 2014. Thus, financial institutions can use the remainder of 2013 to get familiar with the registration process, to input preliminary information, and to refine that information. On or after January 1, 2014, each financial institution will be expected to finalize its registration information by logging into its account on the FATCA registration website, making any necessary additional changes, and submitting the information as final.


Thursday, July 18, 2013

House Passes Legislation Directing FSOC to Study Differences between E.U. and U.S. Credit Derivatives Valuations

The House passed legislation by a vote of 353 to 24 to require the Financial Stability Oversight Council (FSOC) to conduct a study and report to Congress on the likely effects that differences between the U.S. and other jurisdictions, particularly the European Union, in implementing the derivatives credit valuation adjustment capital requirement would have on United States financial institutions that conduct derivatives transactions and participate in derivatives markets. The study would also be required to examine the impact on end users of derivatives and on the international derivatives markets. According to Rep. Stephen Fincher (R-Tenn), the sponsor of the bill, the Financial Competitive Act, H.R. 1341, is needed because of the potential negative impact of Basel III on the U.S. economy.

FSOC study. Specifically, H.R. 1341 requires that the FSOC study include an assessment of the extent to which there are differences in the approaches that the United States and other jurisdictions are taking regarding implementation of the derivatives credit valuation adjustment capital requirement, and the nature of the differences and the impact that the differences would have on U.S. financial institutions that conduct derivatives transactions and participate in derivatives markets, including their ability to serve end users of derivatives.

The study must examine pricing and other costs of, and services available to, end users of derivatives in the United States and other jurisdictions, as well as the competitiveness of U.S. financial institutions and derivatives markets, including the extent to which differences in the credit valuation adjustment capital requirement could shift derivatives business among jurisdictions. The study must also explore the interaction between differing credit valuation adjustment capital requirements and margin rules.
The FSOC study must recommend steps that Congress and the federal financial regulatory agencies that compose FSOC, including the SEC and CFTC, should take to minimize any expected negative effects on U.S. financial institutions, derivatives markets, and end users. The study must also make recommendations encouraging greater global consistency in the implementation of internationally agreed upon capital, liquidity, and other prudential standards.

Rep. David Scott (D-Ga), a co-sponsor of the legislation, has noted that certainty and uniformity are needed on the calculation of the derivatives credit valuation adjustment as it relates to Basel III capital requirements. Financial Services Committee Ranking Member Maxine Waters (D-Cal), in supporting H.R. 1341, observed that regulators must ensure that the calculation of the derivatives credit valuation adjustment is uniform and does not disadvantage U.S. financial institutions.
The Committee approved an amendment sponsored by Rep. Joyce Beatty (D-Ohio) that clarifies that the study must also indentify any risks and threats to financial stability, thereby recognizing FSOC’s mandate to maintain oversight of financial stability. The FSOC study must consider the cost of failing to take regulatory action as well as the cost of taking regulatory action. According to Ranking Member Waters, the amendment requires the FSOC study to report on the impact not just on derivatives markets but also on the wider markets as well.

E.U. Directive. The European Union is implementing Basel III through the vehicle of the Capital Requirements Directive IV (CRD IV), which would exempt E.U. supervised swap dealers from certain Basel III capital mandates, specifically the credit valuation adjustment, when doing business with non-financial end users, pension funds, and sovereign entities. The securities industry finds the CRD IV exemption troubling in that it is a diversion from a uniform application of capital standards and will result in an unlevel playing field for U.S. and other non-E.U. dealers.
Thus, the securities industry supports H.R. 1341 as part of an effort to promote consistent international standards that provide a level playing field, while avoiding market distortions.
Rep. Fincher noted that Canada recently announced a one-year delay of the derivatives credit valuation adjustment, despite having finalized the rest of Basel III, citing the uncertainty around the provision’s global implementation and its effect on non-financial entities.

A Committee staff memorandum issued in connection with the markup noted that the E.U. exemption for derivatives transactions with sovereign, pension fund, and corporate counterparties has raised concerns that derivatives transactions will be subject to different capital requirements and that the credit valuation adjustment could distort the pricing of trades and limit the amount of liquidity available for non-financial U.S. derivatives end-users, as their transactions would not receive the exemption.


The FSOC study is due within 90 days of enactment to the Chairman and Ranking Members of the Committees on Agriculture and Financial Services of the House of Representatives, as well as the Chairman and Ranking Members of the Senate Committees on Agriculture and Banking.

Sunday, July 14, 2013

Advocate General Advises Court of Justice to Reject European Commission Action against Germany over Volkswagen Anti-Takeover Law

The Advocate General of the E.U. Court of Justice issued an opinion urging the Court to dismiss the European Commission’s action against the Federal Republic of Germany to impose penalties for failure to fully comply with the Court's earlier ruling on the amti-takeover Volkswagen law. In his opinion, Nils Wahl found that German federal legislation enacted after the Court’s ruling fully complied with that ruling. The Advocate General’s Opinion, while persuasive, is not binding on the Court of Justice. It is the role of the Advocates General to propose to the Court, in complete independence, a legal solution to the cases for which they are responsible. The Judges of the Court are now beginning their deliberations in this case. Judgment will be given at a later date.

The Volkswagen law was hammered out in 1960 with the participation of workers and trade unions that, in return for relinquishing their claim of ownership rights in the company, secured protection against any large shareholder gaining control. The legislation allows the federal government and Lower Saxony to each appoint two members of the supervisory board and gave them each a 20 percent stake.

In 2007, the Court of Justice ruled that Germany’s Volkswagen Law restricted the free cross-border movement of capital through the intervention of the public sector. The Court found that capping the voting rights of every shareholder at 20 percent regardless of their shareholding violated the requirement that there be a correlation between shareholding and voting rights. The Court also held that provisions in the law conferring two seats each on the company’s supervisory board (equivalent to the board of directors in the US) for the German Federal Republic and the State of Lower Saxony, regardless of their shareholding, also constituted a restriction on the cross-border movement of capital. (European Commission v. Federal Republic of Germany, No. C-112/05).

Subsequent to the Court’s opinion, Germany enacted legislation abolishing the provisions providing for the representation of public authorities on the board and the 20 percent voting cap. But the Commission contends that the legislation did not modify the provision establishing a 20 percent blocking minority in favor of Lower Saxony. Further, no changes were foreseen to the VW Articles of Association, which contain majority voting requirements mirroring the VW law and which were considered as a State measure by the Court.

The Advocate General shares the German government’s reading of the 2007 judgment that the Court found two infringements: the first in relation to the provision on the appointing rights and the second in relation to the provisions on the capping of voting rights and on the blocking minority combined. Therefore, reasoned the Advocate General, by repealing the provision constituting the first infringement and by repealing one of the two provisions constituting the second infringement, Germany has complied fully with the 2007 judgment.

In the Advocate General’s view, the use of the expression in conjunction with in the operative part of the 2007 judgment excludes, on its own, the interpretation proposed by the Commission. In addition, he found that the grounds of the 2007 judgment also fail to confirm the view taken by the Commission. In this respect, he emphasized that the Court, taking into account notably that the Land of Lower Saxony retained an interest in the capital of Volkswagen of approximately 20 %, considered it appropriate to analyze the provisions on the capping of voting rights and the blocking minority together and explicitly referred to the cumulative adverse effects of the two provisions on investors’ interest in acquiring stakes in Volkswagen.

House Passes Legislation Prohibiting PCAOB from Requiring Mandatory Audit Firm Rotation

The House passed the bipartisan Audit Integrity and Job Protection Act, H.R. 1564, by a vote of 321-62, which prohibits the Public Company Accounting Oversight Board from requiring mandatory audit firm rotation. Co-authored by Rep. Robert Hurt (R-VA) and Rep. Gregory Meeks (D-NY), H.R. 1564 would amend Section 103 of the Sarbanes-Oxley Act to expressly prohibit the PCAOB from requiring that the outside audits of a company’s financial statements be conducted by different audit firms on a rotating basis. The Act would also prohibit the Board from requiring that audits be conducted by specific auditors. This is bi-partisan legislation that was reported out of the Financial Services Committee by a vote of 52-0.

Rep. Hurt said that the legislation would eliminate the threat of mandatory audit firm rotation by prohibiting the PCAOB from moving ahead with a potential rulemaking. He mentioned that the Board has put out a concept draft on mandatory audit firm rotation and, to his knowledge, has not withdrawn it. Thus, the PCAOB has left the issue unresolved. In his view, Congress must act because mandatory audit firm rotation would impair auditors, reduce the role and significance of audit committees, reduce audit quality in the first years of the new audit firm’s tender, and create a disincentive to go public.

Rep. Meeks noted that mandatory audit firm rotation would cause significant disruption, could weaken audit quality and is essentially unworkable. He also pointed out that mandatory audit firm rotation was considered during the Dodd-Frank Act deliberations and was rejected. There was no data showing that it would improve audit quality. Rep. Meeks acknowledged that there is some merit to auditor rotation and that Sarbanes-Oxley deals with that by requiring mandatory rotation of the lead partner responsible for the audit.

Although she voted for passage of H.R. 1564 in the House, the Committee’s Ranking Member, Rep. Maxine Waters (D-Cal.) has viewed the legislation with mixed feelings. On the one hand, she does not believe that mandatory audit firm rotation would enhance auditor independence, but on the other hand she does not believe that Congress should micromanage the PCAOB. The small number of audit firms and industry specialization means that requiring audit firm rotation will leave companies with little choice. Essentially, the dominance of the Big 4 makes mandatory audit firm rotation unworkable. But again, the Ranking Member is concerned with tampering with PCAOB authority at a time when it is not clear how serious the Board is about mandatory audit firm rotation. It is not unreasonable for the PCAOB to consider a wide and broad range of issues, she added. However, the Ranking Member cautioned the Board to keep in mind if there are any benefits to investors as it examines mandatory audit firm rotation.

During Committee mark-up of H.R. 1564, Rep. Waters offered an amendment to H.R. 1564 that would sunset the prohibition on adopting mandatory audit firm rotation so as not to indefinitely constrain the PCAOB. The amendment would also require a study on the issue, updating the 2003 GAO study. Rep. Hurt opposed the amendment, stating that it would gut the bill and create uncertainty. Rep. Scott Garrett (R-N.J.) proposed an amendment to the Waters Amendment that would eliminate the sunset provision, but retain the study. Rep. Hurt agreed to the compromise amendment as long as it specifically required the study to consider the costs of mandatory audit firm rotation. Rep. Waters agreed to the changes, indicating that cost considerations should be included in the amendment. The amendment requiring a study of mandatory audit firm rotation, updating the GAO 2003 study, was unanimously approved by voice vote in the committee.

While Applauding Regulatory Adoption of Leverage Ratios, Senators Brown and Vitter Say Legislation to End TBTF Still Needed

Senators Sherrod Brown (D-OH) and David Vitter (R-LA) applauded the plans of federal regulators to increase the mandatory leverage ratio for financial institutions while at the same time stating that their legislation, the Terminating Bailouts for Taxpayer Fairness Act (TBTF Act), must still be passed to ensure that financial institutions have adequate capital to protect against losses and end too-big-to-fail. The increase in the leverage ratio is a major step forward, said the Senators, but it is only the first step.

Despite receiving assistance from taxpayers in 2008, today, noted the Senators, the nation’s four largest financial institutions, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, are nearly $2 trillion larger today than they were before the crisis. Their growth has been aided by an implicit guarantee, said the Senators, funded by taxpayers and awarded by virtue of their size, and the market knows that these institutions have been deemed “too big to fail.” This allows the largest financial institutions to borrow at a lower rate than regional banks, community banks, and credit unions. This funding advantage, which has been confirmed by three independent studies in the last year, is estimated to be as high as $83 billion per year.

Senators Brown and Vitter reaffirmed their strong commitment to the Terminating Bailouts for Taxpayer Fairness Act (TBTF Act), which would set reasonable capital standards that would vary depending on the size and complexity of the financial institution. Economic and financial experts agree that adequate capital is critical to financial stability, reducing the likelihood that an institution will fail and lowering the costs to the rest of the financial system and the economy if it does. Under the legislation, financial institutions with more than $500 billion in assets would be required to meet a new 15 percent capital requirement.

Former Senator Lincoln Calls on New OIRA Chief to Find the Right Regulatory Balance

Former Senator Blanche Lincoln (D-Ark), and a key architect of the Dodd-Frank Act, urged Howard Shelanski, the new Administrator of the Office of Information and Regulatory Affairs to balance the important role many federal regulations play with the uncertainty they create and costs they impose on job creators. She said that far too many regulations continue to be hastily implemented before thorough consideration is given to all available science and data, public input, and the direct and indirect impacts they will have on businesses.

The former Chair of Senate Agriculture Committee, and author of Title VII of the Dodd-Frank Act, asked the OIRA chief to reassurance small businesses that he will not heed calls to speed up a regulatory process that too often fails to find the right balance or answers because it neglects asking the right questions. She called on OIRA to usher in an era of common sense reforms to make the creation of regulations more transparent, accountable and less harmful to the economy.

Senate Companion Bill Would Codify Dodd-Frank Derivatives End-User Exemption

 Senators  Mike Johanns (R-NE) and Jon Tester (D-MT.) are leading a bipartisan coalition of Senators in introducing a bill to codify the Dodd-Frank Act derivatives end-user exemption for non-financial commercial companies that  use derivatives to manage their risk and insure against extreme price fluctuations for commodities critical to their business operations. Senator Mark Warner (D-VA), a key member of the Banking Committee, is co-sponsoring  the bill, along with the Committee’s Ranking Member Senator Larry Crapo (R-ID). S. 888  is companion bill to H.R. 634, which was favorably reported out of the House Financial Services Committee by a 59-0 vote and is almost certainly headed for passage by the full House.

The Senate bill  is identical to H.R. 634, and clarifies current law by making explicit that commercial end-users are not subject to costly margin requirements, consistent with Congress’ intent in Dodd-Frank. End-users are the final user of a good or product.  Dodd-Frank legislative history indicates an exemption for non-financial end-users based on the low risks they pose to the financial system.  Despite Congress’ intent, there has been a debate over how broadly the exemption would apply.  While the CFTC and SEC previously issued a joint rule that would exempt end-users from margin, the Federal Reserve has issued regulations that would capture many end-users in their regulati

Wednesday, July 10, 2013

In Letter to Senate leaders, Former CFTC and Acting CFTC Chairs Back Legislation Requiring Cost-Benefit Analysis of SEC and CFTC Regulations

In letters to Senate leaders, two former CFTC Acting Chairs and a former Chair  expressed strong support for the bipartisan Independent Regulatory Analysis Act, S. 3468. Introduced by Senators Mark Warner (D-VA), Rob Portman, and Susan Collins (R-ME), S. 3468 would require independent federal agencies, such as the SEC and CFTC, to conduct a cost-benefit analysis of new regulations and tailor new regulations to minimize unnecessary burdens on the economy. The bill would also provide for review by the Office of Information and Regulatory Affairs (OIRA) of every proposed and final economically significant regulation, pegged at economic impact of $100 million or more, followed by a public exchange of views between OIRA and the independent agency concerning the quality of the agency’s cost-benefit analysis. Although OIRA would not have the power to reject a regulation, it would place its evaluation of the agency’s cost-benefit analysis in the public record.

In their letter to Senator Tom Carper (D-DE), Chair of the Homeland Security and Governmental Affairs Committee and Ranking Member Tom Coburn (R-OK), former CFTC Acting Chairs Sharon Brown-Hruska and William Albrecht said that the bi-partisan legislation would promote a more cost-effective approach to regulation by affirming the President’s authority to extend to independent agencies the same principles of regulation that have long governed executive agencies. The former CFTC officials noted that the legislation take a balanced approach to extending cost-benefit analysis to independent federal agencies by providing for OIRA review of economically significant regulations, followed by a public exchange of views between OIRA and the SEC, CFTC other independent agency concerning the quality of the agency’s cost-benefit analysis and other basic considerations.

In this respect, said the former CFTC Acting Chairs, it takes an approach quite similar to that Congress took in providing for review of independent agency actions under the Paperwork Reduction Act. The proposed legislation carefully preserves the independence of the SEC, CFTC and other affected agencies, assured the former CFTC officials, since it explicitly states that OIRA’s assessment of independent agency rules submitted for review is nonbinding. Under S. 3468, they reasoned, accountability comes through the public exchange of views between OIRA and the agencies. Indeed, the bill does not permit judicial review of an agency’s compliance with the terms of the executive order, and it confers no power on OIRA to stop independent agency rules.

In a separate letter to the Senate leaders in her capacity as a former OIRA Administrator, former CFTC Chair Wendy Lee Gramm essentially agreed with the views of the two former  Acting CFTC Chairs.  Chairman Gramm was joined by five other OIRA former Administrators. As former OIRA Administrators from Democratic and Republican administrations, they were unanimous in their view that independent regulatory agencies should be held to the same good-government standards as executive agencies, and the Independent Agency Regulatory Analysis Act advances that goal.

 

In Wake of Ruling Vacating SEC Resource Extraction Rule, Senator Cardin Re-Affirms Belief in Public Disclosure

In the aftermath of a federal court ruling vacating the SEC’s Dodd-Frank resource extraction disclosure rule, Senator Ben Cardin (D-MD) has reaffirmed his belief in the public disclosure of annual reports of resource extraction payments that energy companies may have made to governments. Senator Cardin, along with former Senator Richard Lugar (R-IN), is a co-author of Section 1504 of the Dodd-Frank Act, codified as Section 13(q) of the Exchange Act, which directed the SEC to adopt regulations requiring resource extraction issuers engaged in the development of oil, natural gas, or minerals to disclose payments made to the federal government or foreign governments.

In a statement, Senator Cardin expressed disappointment with the ruling, which essentially instructed the SEC to redraft the regulation. He noted that Congress was clear both in the letter and spirit of Section 1504 that this information should be in the public domain. The senator lamented that the federal court ruling will delay implementation of vital transparency rules that would shine much needed light on information designed to protect investors and promote U.S. energy security.

A federal judge vacated and remanded the SEC regulation implementing the resource extraction payment disclosure section of the Dodd-Frank Act because the Commission misread the statute to mandate public disclosure and its decision to deny any exemption from the disclosure requirement was, given the limited explanation provided, arbitrary and capricious. The court found that Section 13(q) requires disclosure of annual reports but says nothing about whether the disclosure must be public or may be made to the Commission alone.

Thursday, July 04, 2013

U.K. FCA Charts New Philosophy of Judgment-Based, Real Time Financial Regulation

The main duty or Government remit of a securities regulator is to ensure that the financial markets work well for all the market participants, said Martin Wheatley, the Chief Executive of the U.K. Financial Conduct Authority. In recent remarks, he noted that the FCA has developed a forward-looking and judgment-based philosophy of financial regulation to ensure the well-functioning of the markets. The FCA will employ real time regulation and eschew box-ticking and regulation based on historic data collection. The FCA espouses regulation that is outcome-based and employs the tactic of early intervention.

Mr. Wheatly clarified that a market that works well has to work for all players in the market. But it is not a market where consumers never lose money, he said, since markets are about risk and in the appropriate product, consumers may gain or lose. It is also not a market where firms never make money, since the provision of services is rarely free and firms have to be allowed to make a profit. Thus, a market that works well has profits for good firms and exits for bad ones, along with innovation and choice for consumers and good products that meet consumers’ needs and not bad products that simply obscure cost or risks.

Specifically regarding the asset management industry, Mr. Wheatley pledged that the FCA will work closely with hedge fund managers and other asset managers in a productive, predictable and transparent relationship that supports growth by delivering innovation and valued services to clients. In practice, this means the FCA will work alongside all participants, including the Government and asset managers, to support the market and to allow asset managers to contribute to the economy. It also means the FCA should be easier to access and engage with in critical areas like fund authorization and implementation of a new policy like the E.U. Alternative Investment Fund Managers Directive (AIFMD).

Enforcement at UK FCA will focus on attestation as part of personal accountability says Martin Wheatley

In enforcement actions, the new U.K Financial Conduct Authority will place enhanced significance on personal conduct in financial services in pursuing far more cases against executives and obtaining fines and criminal prosecutions. All this will mean an increased focus on personal accountability, said FCA Chief Executive Martin Wheatley. In remarks a recent FCA seminar, he noted that, in the spirit of personal accountability, there will be a much greater regulatory use of attestations, which the Chief Executive described as legal affirmations that focus the minds of senior executives by requiring them to sign on the dotted line and stake their professional reputation and authority on the quality of their firm’s compliance processes.

FCA enforcement practice will be conducted in a more confident, intelligent and sophisticated manner, pledged the agency head. The mechanisms and moral benchmarks the agency will work towards are almost completely divorced from those of ten or fifteen years ago.

Thus, where once teams worked in what the Executive Director called ``baronies’’, the FCA will now place a significant emphasis on the importance of the threads that run across and between divisions. For example, staff in the trading and markets departments are working on a daily basis with enforcement staff at every level of the organization.

Federal Judge Vacates SEC Regulation Implementing Dodd-Frank Resource Extraction Payment Disclosure Provision

A federal judge vacated and remanded the SEC regulation implementing the resource extraction payment disclosure section of the Dodd-Frank Act because the Commission misread the statute to mandate public disclosure and its decision to deny any exemption from the disclosure requirement was, given the limited explanation provided, arbitrary and capricious. The Commission fundamentally miscalculated the scope of its discretion at critical junctures, said the court, viewing itself as shackled by the words “report” and “compilation,” when neither could be read to limit its authority. Now informed that it does have more authority under the statute than it thought it had, the Commission may well strike a different balance. American Petroleum Institute, et al. v. SEC, July 2, 2013, Bates, J.

Co-authored by Senators Ben Cardin (D-MD) and Richard Lugar (R-IN), Section 1504 of the Dodd-Frank Act, codified as Section 13(q) of the Exchange Act, directed the SEC adopted regulations requiring resource extraction issuers engaged in the development of oil, natural gas, or minerals to disclose payments made to the federal government or foreign governments.

Section 13(q) provides that the Commission must issue final rules requiring each resource extraction issuer to include in an annual report information relating to any payment made to a government for the commercial development of oil, natural gas, or minerals. The statute’s plain language poses an immediate problem for the Commission, noted the court, because it says nothing about public filing of these reports. Thus, the Commission’s argument that the statute unambiguously requires public filing is, in the court’s view, ``a climb up a very steep hill.’’

Section 13(q) also states that, to the extent practicable, the Commission shall make available online, to the public, a compilation of the information required to be submitted under the rules issued under the annual report provision. According to the court, a natural reading of this provision is that, if disclosing some of the information publicly would compromise commercially sensitive information and impose high costs on shareholders and investors, then the SEC may selectively omit that information from the public compilation. The Commission points to nothing prohibiting that reading.

Indeed, reasoned the court, the Commission’s approach reads the to the extent practicable limit out of the statute since, if it is not practicable to make a compilation available, it is likely impracticable to make all the information available through full disclosure of the annual reports themselves and, conversely, once the full reports were public, there would be little to make compilation of them online impracticable

Thus, the court concluded that Section 13(q) requires disclosure of annual reports but says nothing about whether the disclosure must be public or may be made to the Commission alone. Neither the dictionary definition nor the ordinary meaning of “report” contains a public disclosure requirement. And section 13(q) expressly addresses public availability of information by establishing a different and more limited requirement for what must be publicly available than for what must be annually reported. Topping things off, the Exchange Act as a whole uses the word “report” to refer to disclosures made to the Commission alone. If this is Congress’s way of unambiguously dictating that reports must be publicly filed, said the court, it is a peculiar one indeed.

Faced with these powerful indicia that Congress left the public availability of reports unspecified, the Commission offered no persuasive arguments that the statute unambiguously requires public disclosure of the full reports.

The Commission made another serious error that independently invalidates the regulation by the arbitrary and capricious denial of any exemption for countries that prohibit payment disclosure. Congress has endowed the Commission with authority to make exemptions from certain Exchange Act provisions, including Section 13(q), said the court. Aside from any statutory duty to act, moreover, an agency decision as to exemptions must, like other decisions, be the product of reasoned decision making.

The Commission’s primary reason for rejecting an exemption does not hold water, said the court. The Commission argued that an exemption would be inconsistent” with the structure and language of Section 13(q). But this argument ignores the meaning of “exemption,” noted the court, which, by definition, is an exclusion or relief from an obligation, and hence will be inconsistent with the statutory requirement on which it operates.

IASB Chair Sets Out Ten-Point Plan to Break Boilerplate of Financial Statement Disclosure

In significant remarks at a recent IFRS Foundation seminar, IASB Chair Hans Hoogervorst set forth a ten-point plan to break the boilerplate of uncommunicative and box-ticking financial statement disclosure. The Chair fears that, without a game-changing initiative, company annual reports are destined to become simply compliance documents rather than instruments of communication to investors and other users of financial statements.

Broadly, the Board will undertake a general review of disclosure requirements in existing Standards (Pt. 10) after it has already conducted a fundamental review of IAS 1, IAS 7 on financial instruments and IAS 8 on operating segments (Pt. 9). More specifically, the Board will clarify in IAS 1 that the materiality principle does not only mean that material items should be included, but that it can mean that it can be better to exclude nonmaterial disclosures. (Pt. 1). Too much detail can make the material information more difficult to understand, said the IASB Chair, as he urged companies to proactively reduce the clutter.

Many preparers of financial statements will err on the side of caution and throw everything into the disclosures, he noted, since they do not want to risk being asked by the regulator to restate their financials. No CFO has ever been fired for producing voluminous disclosures, he observed. Moreover, excessive disclosures can be handy for burying unpleasant, yet very relevant, information.

The IASB will also clarify that a materiality assessment applies to the whole of the financial statements, including the notes (Pt. 2). Many persons think that items that do not make it onto the face of primary financial statements as a line item need to be disclosed in the notes, he said. The Board will clarify this is not the case. If an item is not material, he reasoned, it need not be disclosed anywhere at all in the financial statements.

Relatedly, the Board will remove language from IAS 1 that has been interpreted as prescribing the order of the notes to the financial statements. This should make it easier for companies to communicate their information in a more logical and holistic fashion (Pt. 4). The Board will clarify that if a Standard is relevant to the company’s financial statements, it does not automatically follow that every disclosure requirement in that Standard will provide material information. Instead, each disclosure will have to be judged individually for materiality (Pt. 3).

The Board will ensure that IAS1 gives companies flexibility about where they disclose accounting policies in the financial statements. (Pt. 5). According to Chairman Hoogervorst, important accounting policies should be given greater prominence in financial statements and less important accounting policies relegated to the back of the financial statements.

At the request of global users of financial statements, the Board will consider adding a net-debt reconciliation requirement in order to provide users with clarity around what the company is calling net debt and also to consolidate and link the clutter of scattered debt disclosures through the financial statements. (Pt. 6). Working with IOSCO and the IAASB, the Board will look into the creation of either general application guidance or educational material on materiality in order to provide auditors, preparers and regulators with a clear and uniform view of what constitutes material information. (Pt. 7). Finally, the Board will use less prescriptive wordings when developing new disclosure Standards, focusing on disclosure objectives and examples of disclosures that meet that objective.

Senate confirms Howard Shelanski as OIRA Administrator in Voice Vote

Against the backdrop of two Executive Orders on federal agency rulemaking, ant at a critical moment when legislation is pending to require independent federal agencies to conduct a cost-benefit analysis of regulations, the U.S. confirmed by voice vote Howard Shelanski to be the next Administrator of the Office of Information and Regulatory Affairs.

Mr. Shelanski is the Director of the Bureau of Economics at the Federal Trade Commission, a position he has held since 2012. He is currently on leave from the Georgetown University Law Center, where he has been a professor since 2011. Mr. Shelanski was the Deputy Director for Antitrust in the FTC’s Bureau of Economics from 2009 to 2011. He served as Chief Economist of the Federal Communications Commission from 1999 to 2000 and as Senior Economist for the President’s Council of Economic Advisers from 1998 to 1999.

At his nomination hearing before the Committee, Mr. Shelanski noted that OIRA plays an essential role in developing and overseeing the implementation of Government-wide policies on regulation, information collection, information quality and technology, statistical standards, scientific evidence, and privacy. He believes that public involvement and transparency in regulation is critically important as we tackle the complex issues of regulation both domestically and globally.

Asked by Committee Chairman Tom Carper (D-DE) to list his top priorities as OIRA Administrator, he listed three. The first is to ensure that regulatory review occurs in a timely manner and that it is a high quality review. Second, he intends to form good working relationships with agency heads and with Congress, as well as with public stakeholders. Third, OIRA will conduct retrospective  reviews  and look backs of adopted regulations even as the Office moves forward with new regulations. OIRA will look back to ensure that the regulations already  on the books are not overly burdensome and are doing what they were intended to do. The Administrator-designate added that, regarding retrospective review, the primary duty is with the agency heads since they best know their regulations. To Chairman Carper’s query if such retrospective review will be ongoing, he replied that it would be.



Executive Orders. President Obama issued two significant Executive Orders on the federal regulatory process during his first term: Executive Order No. 13563, 76 Fed. Reg. 3,821 (Jan. 21, 2011) and Executive Order No. 13579, 76 Fed. Reg. 41,587 (July 14, 2011). EO No. 13563 set out general requirements directed to executive agencies concerning public participation, integration and innovation, flexible approaches, and science. It also reaffirmed that executive agencies should conduct a cost-benefit analysis of regulations. EO No. 13579 states that independent regulatory agencies should follow EO No. 13563. Mr. Shelanski assured the Senate that he would faithfully follow these Executive Orders.

Senate confirms Howard Shelanski as OIRA Administrator in Voice Vote

Against the backdrop of two Executive Orders on federal agency rulemaking, ant at a critical moment when legislation is pending to require independent federal agencies to conduct a cost-benefit analysis of regulations, the U.S. confirmed by voice vote Howard Shelanski to be the next Administrator of the Office of Information and Regulatory Affairs.

Mr. Shelanski is the Director of the Bureau of Economics at the Federal Trade Commission, a position he has held since 2012. He is currently on leave from the Georgetown University Law Center, where he has been a professor since 2011. Mr. Shelanski was the Deputy Director for Antitrust in the FTC’s Bureau of Economics from 2009 to 2011. He served as Chief Economist of the Federal Communications Commission from 1999 to 2000 and as Senior Economist for the President’s Council of Economic Advisers from 1998 to 1999.

At his nomination hearing before the Committee, Mr. Shelanski noted that OIRA plays an essential role in developing and overseeing the implementation of Government-wide policies on regulation, information collection, information quality and technology, statistical standards, scientific evidence, and privacy. He believes that public involvement and transparency in regulation is critically important as we tackle the complex issues of regulation both domestically and globally.

Asked by Committee Chairman Tom Carper (D-DE) to list his top priorities as OIRA Administrator, he listed three. The first is to ensure that regulatory review occurs in a timely manner and that it is a high quality review. Second, he intends to form good working relationships with agency heads and with Congress, as well as with public stakeholders. Third, OIRA will conduct retrospective  reviews  and look backs of adopted regulations even as the Office moves forward with new regulations. OIRA will look back to ensure that the regulations already  on the books are not overly burdensome and are doing what they were intended to do. The Administrator-designate added that, regarding retrospective review, the primary duty is with the agency heads since they best know their regulations. To Chairman Carper’s query if such retrospective review will be ongoing, he replied that it would be.



Executive Orders. President Obama issued two significant Executive Orders on the federal regulatory process during his first term: Executive Order No. 13563, 76 Fed. Reg. 3,821 (Jan. 21, 2011) and Executive Order No. 13579, 76 Fed. Reg. 41,587 (July 14, 2011). EO No. 13563 set out general requirements directed to executive agencies concerning public participation, integration and innovation, flexible approaches, and science. It also reaffirmed that executive agencies should conduct a cost-benefit analysis of regulations. EO No. 13579 states that independent regulatory agencies should follow EO No. 13563. Mr. Shelanski assured the Senate that he would faithfully follow these Executive Orders.

UK Legislative Panel Proposes Sweeping Reform of Regulation of Financial Institutions

A more effective enforcement and sanctions regime against individuals is the centerpiece of a proposed sweeping and radical revision of the regulation of financial institutions proposed by the U.K. Parliamentary Commission on Banking Standards. As the U.K. moves towards legislation ring fencing investment banking from retail banking in its version of the Volcker Rule, the attribution of individual responsibility will, for the first time, provide for the full use of the range of civil powers that regulators already have to sanction individuals, including fines and a ban from the industry.

In the case of failure leading to successful enforcement action against a firm, there will be a requirement for relevant senior officers to demonstrate that they took all reasonable steps to prevent or mitigate the effects of a specified failing. Those unable to do so would face possible individual enforcement actions, switching the burden of proof away from the regulators. In addition, a criminal offense will be established applying to senior management carrying out their professional responsibilities in a reckless manner, which may carry a prison sentence. Following a conviction, the remuneration received by an individual during the period of reckless behavior would be clawed back through separate civil proceedings.

The Commission recommends a new criminal offense for reckless misconduct in the management of a financial firm. Be in no doubt about the difficulty of securing a conviction for such a new offense, said the Commission. But, it should be implemented based on the reasoning that the possibility of criminal liability for recklessly carrying out professional duties would give pause to the senior officers of UK financial institutions. The Commission recommends that the offense be limited to individuals covered by the new Senior Persons Regime, so that those concerned would have no doubts about their potential criminal liability. Further, the Commission would expect this offense to be pursued in cases involving only the most serious failings, such as where a financial firm failed with substantial costs to the taxpayer, lasting consequences for the financial system, or serious harm to customers.

Corporate Governance. The Commission also proposes a deep and far reaching reform of corporate governance so that there are individual and direct lines of access and accountability to the board of directors for the heads of the risk, compliance and internal audit functions and much greater levels of protection for their independence. There should also be direct personal responsibility on the board chairman to ensure the effective operation of the board, including effective challenge by non-executive directors, and on the Senior Independent Director, supported by the regulator, to ensure that the chairman fulfils this role. Whistle blowing procedures should be overseen by a named non-executive director, who would be held accountable when an individual suffers detriment as a consequence of blowing the whistle.

Ass part of the reform of corporate governance, the Commission calls for an end to box checking by regulators and a move towards judgment-based financial regulation. Regulators should identify the risks to a judgment-based approach from overly prescriptive international rule books and ensure that Parliament is kept fully informed of them. Importantly, there should be mandatory dialogue between regulators and the external auditors of financial statements and a separate set of accounts for regulatory purposes.

Very importantly, the Commission emphasized that non-executive directors in systemically important financial institutions should have a particular duty to take a more active role in challenging the risks that businesses are running and the ways that they are being managed. For non-executive directors to be more effective, they may need to make more use of their current powers under the U.K. Corporate Governance Code to obtain information and professional advice, both internally and externally. In this context, it is essential that the office of the board chairman be well-resourced so that it can provide independent research and support to the non-executive directors.

More granularly with regard to corporate governance, fundamental reform may be needed to the nominating process, especially concerning non-executive independent directors. The Commission asks the Financial Reporting Council, which has oversight of the U.K. Corporate Governance Code, to publish proposals, within six months, to address the widespread perception that some natural challengers are sifted out by the
nomination process.

There is a danger that non-executives directors are self-selecting and self-perpetuating. In the interests of transparency, and to ensure that such directors remain as independent as possible, the Commission recommends that the regulators examine the merits of requiring each non-executive vacancy on the board above the ring-fence threshold to be publicly advertised.

The obligations of directors to shareholders in accordance with the provisions of the Companies Act of 2006 create a particular tension between duties to shareholders and financial safety and soundness. For as long as that tension persists, said the Commission, it is important that it be acknowledged and reflected in the UK Corporate Governance Code and in the new Senior Persons Regime. The Commission has several recommendations in the light of this, which should at the very least apply to financial institutions above the ring-fence threshold.

The UK Corporate Governance Code must be amended to require directors of financial institutions to attach the utmost importance to the safety and soundness of the firm and for the duties they owe to customers, taxpayers and others in interpreting their duties as directors. In this respect, Section 172 of the Companies Act of 2006 should be amended to remove shareholder primacy and require directors to ensure the financial safety and soundness of the company ahead of the interests of its members.

In a radical move, the Commission recommends that the Senior Independent Director should, under the proposed Senior Persons Regime, have the specific duty to annually assess the performance of the board chairman and, as part of this duty, ensure that the relationship between the CEO and the chairman does not become too close and that the chairman performs his or her leadership and challenge role.

The Commission expects the regulators to maintain a dialogue with the Senior Independent Director on the performance of the Chairman. In fact, the Senior Independent Director should meet with the regulators each year to explain how the Chairman has held the CEO to account, encouraged meaningful challenge from other independent directors and maintained independence in leading the board.

Each board should have a separate risk committee chaired by a non-executive director who possesses industry knowledge and strength of character to challenge the executive effectively. The risk committee should be supported by a strong risk function, led by a Chief Risk Officer, with authority over the separate
business units. Boards must protect the independence of the Chief Risk Officer, and personal responsibility for this should lie with the chair of the risk committee.The Chief Risk Officer should not be able to be dismissed or sanctioned without the agreement of the non-executive directors, and his or her remuneration should reflect this requirement for independence.

The Commission proposes a new tool, special measures, which are designed to provide for the deployment of a broader range of regulatory powers when the Financial Conduct Authority and the Prudential Regulation Authority are concerned that systemic weaknesses of leadership, risk management and control leave a firm particularly prone to standards failures.

Special Persons Regime. As the primary framework for regulators to engage with individuals, said the Commission, the current Approved Persons Regime is a complex and confused mess. It fails to perform any of its varied roles to the necessary standard. It is the mechanism through which individuals can notionally be sanctioned for poor behavior, but its coverage is woefully narrow and it does not ensure that individual responsibilities are adequately defined, thereby restricting regulators’ ability to take enforcement action.

The proposed Senior Persons Regime should provide far greater precision about individual responsibilities and would serve as the foundation for some of the changes to enforcement powers. The new regime will encourage greater clarity of responsibilities and improved corporate governance and establish beyond a doubt the individual responsibility that can provide a sound basis for the regulators to impose remedial requirements or take enforcement actions.

Remuneration. The current remuneration regime must be reformed to align risk and reward and stop incentivizing poor behavior. The Commission recommends that a new Remuneration Code be introduced on the basis of a new statutory provision.

The Commission recommends that statutory remuneration reports be required to disclose expected levels of remuneration in the coming year by division, assuming a central planning scenario and, in the following year, the differences from the expected levels of remuneration and the reasons for those differences. The disclosure should include all elements of compensation and the methodology underlying the decisions on remuneration. The individual remuneration packages for executive directors and all those above a threshold determined by the regulator should normally be disclosed, unless there is a good reason for not doing so. The Commission further recommends that the remuneration report should be required to include a summary of the risk factors that were taken into account in reaching decisions and how these have changed since the last report.

The Commission did not go so far as to recommend the setting of levels of remuneration by Government or regulators. However, the Commission reminded financial firms that many consider the levels of reward in recent years to have grown to grotesque levels at the most senior ranks and that such reward often bore little relation to any special talents.

Ideally, remuneration requirements should be mandated internationally in order to reduce arbitrage. The Commission expects U.K. authorities to strive to secure international agreement on changes which are focused on the deferral, conditionality and form of variable remuneration, and the measures for its determination, rather than simply the quantitative relationship to fixed remuneration, because it is changes of this kind that will most improve behavior in the long term. In particular, the Government should ensure that the standards under the CRD IV Directive contain sufficient flexibility for national regulators to impose requirements in relation to instruments in which deferred bonuses can be paid which are compatible with the reform.