Friday, January 31, 2014

E.C. Proposals Would Ban Proprietary Trading, Illuminate Shadow Banking

The European Commission (E.C.) has issued twin proposals to ban big banks’ proprietary trading and to improve shadow-banking transparency. The proposed regulations work in tandem to avoid a scenario in which a bank could evade the proprietary trading ban by hiding risky activities in other corners of its business, said a press release announcing the proposals.

The proprietary trading ban is a more aggressive tack than the one floated in the 2012 Liikanen report, which recommended that banks separate their riskiest activities from their deposit-taking functions. The report had concluded that excessive risk and the interconnectedness of financial institutions, not any particular banking model, likely explained the 2008 global financial crisis. A summary of the proposed ban, however, said the E.C. did not intend to end the universal banking model.

Commissioner Michel Barnier described the proposals as the “final cogs” needed to ensure the end of too-big-to-fail and the era of taxpayer bailouts. “This legislation deals with the small number of very large banks which otherwise might still be too-big-to-fail, too-costly-to-save, too-complex-to-resolve.”

Commissioner Barnier also noted that the proposals would establish a common framework to uphold the E.U.’s single market and would seek to balance regulatory goals with economic growth. Said Barnier, “The proposals are carefully calibrated to ensure a delicate balance between financial stability and creating the right conditions for lending to the real economy, particularly important for competitiveness and growth.”

Private sector reaction to the proposals was mixed. Clifford Smout, co-head, Deloitte Centre for Regulatory Strategy, said that passage by the European Parliament and Council is not assured. He also noted that the ban on proprietary trading is similar to the U.S. Volcker Rule, but is much tougher than current European Union rules. “Even if the ECB ends up taking the lead on these issues within the eurozone, there could be inconsistencies between these rules and those in operation elsewhere,” said Smout.

“Although well trailed, the big surprise is the total ban on proprietary trading which goes beyond the original Liikanen proposals,” said Giles Williams, regulatory partner, KPMG, in a statement. Williams also cautioned that the proposal may spur regulators to focus on shadow banking. “These proposals signal an intentional push of risky trading activity into the shadow banking sector, which is likely to be the next target for regulation.”

Proprietary trading. Article 6(1) of the bank structural reform proposal would ban all proprietary trading that is done solely to enhance bank profits. The ban, however, would not apply to financial instruments issued by a member state’s central government or to bank cash management processes that involve cash or highly liquid cash equivalent investments with low risk and shorter maturities.

The proprietary trading ban also would apply only to the largest banks that meet the “entities” definition in Article 3. As a result, the ban applies to any credit institution or E.U. parent that has been designated a global, systemically important institution under the relevant E.U. directive. The ban also applies to an E.U. credit institution that is neither a parent nor a subsidiary, an E.U. parent that has a group entity that is an E.U. credit institution, and E.U. branches of credit institutions organized in third countries. These other entities must have, in a consecutive three-year period, at least €30 billion in total assets and trading activities in excess of either €70 billion or 10 percent of total assets.

The proposal also would permit subsidiarization within a banking group to deal with some risky trading activities. Article 8(1) defines “trading activities” to mean activities other than insured deposits, consumer and commercial lending, financial leasing, payment services, travellers’ cheques and bankers’ drafts, money broking (including safekeeping and administration of securities), credit reference services, safe custody services, and the issuance of electronic money.

Bank supervisors would need to monitor banks’ trading activities regarding market making, securitizations, and derivatives trading under Article 9(1). If the supervisor found that a bank’s trading activities threatened the bank’s (“core credit institution’s”) financial stability or the whole E.U. financial system, it must begin proceedings under Article 10(1) or 10(2) to determine if the trading activity should be separated from the bank’s deposit taking functions.

A bank can rebut the supervisor’s decision under Article 10(3). A bank that is subject to a decision under Article 10, however, may still engage in trading activities under Article 11 to prudently manage its own risk. Likewise, Article 12 lets a bank that is the subject of an Article 10 decision sell certain types of derivatives for hedging purposes if the bank’s funds requirements do not exceed a proportion of its total risk capital requirement as set by a future E.C. delegated act.

Upon a banking supervisor’s finding that a trading activity is not permitted to a bank that is part of a group, the trading activity may be done only by a separate “trading entity” that is legally, economically, and operationally distinct from the bank. A bank also may voluntarily separate trading activities into a trading entity upon the banking supervisor’s approval of an Article 18 separation plan.

Shadow banking. The E.C.’s related proposal on shadow banking would shed new light on banking-like activities that occur outside the traditional banking sector. These activities can resemble bank deposits, enable maturity or liquidity transformation, or involve the transfer of credit risk or the use of leverage. According to a FAQ, the proposal aims to improve shadow-banking transparency in a way that is consistent with prior recommendations of the Financial Stability Board.

Article 2(1) would apply the proposed transparency regime to counterparties to securities financing transactions (SFTs) established in the E.U. and to certain foreign SFTs that use E.U. branches. Management companies of undertakings for collective investment in transferable securities (UCITS) and managers of alternative investment funds (AIFMs) that are subject to the E.U.’s UCITS and AIFM directives are included. The proposal’s scope also snares counterparties who engage in certain rehypothecations.

The heart of the proposal is a reporting regime that would make SFTs less opaque. Article 4(1) requires SFT counterparties to report these transactions to a trade repository. Details of SFTs must be reported by the working day after the SFT was concluded, modified, or terminated.

Trade repositories would be required to register with the European Securities and Markets Authority (ESMA) under Article 5(1). The proposal said the use of trade repositories for SFTs would better equip banking supervisors to spot ties between traditional banks and entities that operate within the shadow-banking system. To achieve transparency, Article 12(1) would require trade repositories to “regularly” publish aggregate data on the SFTs reported to them by SFT counterparties. Article 19 lets ESMA recognize third countries’ trade repositories and enter into cooperation agreements with third countries.

Article 13(1) mandates certain disclosures by UCITS firms and AIFMs to their investors regarding how these entities use SFTs. Article 15 provides for the right of counterparties to rehypothecation if the specified requirements are met.

Under Article 20, E.U. member states must establish administrative sanctions for breach of the Article 4 reporting obligation and the Article 15 rehypothecation right. Article 21 lists the factors member states must consider when imposing administrative sanctions. Article 24 requires that decisions resulting in administrative sanctions, and any appeals of those decisions, must be published by the member state’s supervisory authority on its website.

Friday, January 24, 2014

E.U. Court of Justice Rules ESMA Powers under Short-Selling Directive are Proper

The Court of Justice of the European Union ruled that Article 28 of the Short Selling Regulation authorizing the European Securities and Markets Authority (ESMA) to adopt measures under the Regulation is a proper delegation under E.U. treaty law. ESMA’s authority under Article 28 was challenged by the U.K. United Kingdom v. European Parliament, No. C-270/12, January 22, 2014.

In reaching its decision, the Court noted that ESMA’s exercise of power under the Regulation is circumscribed by various conditions and criteria which limit ESMA’s discretion. For example, ESMA can only adopt measures under the provision that address a threat to the financial markets or the stability of the E.U. financial system and that raise cross-border implications. Moreover, all ESMA measures are subject to the condition that no competent national authority has taken measures to address the threat or one or more of those authorities have taken measures which have proven not to address the threat adequately.

In addition, ESMA is required to take into account the extent to which such measures address the threat to the financial markets or the stability of the financial system or significantly improve the ability of the competent national authorities to monitor the threat. ESMA must also ensure that such measures do not create a risk of regulatory arbitrage and do not have a detrimental effect on the efficiency of financial markets, including by reducing liquidity in those markets or creating uncertainty for market participants which is disproportionate to the benefits of the measure.

Even more, ESMA is required to consult the European Systemic Risk Board and, if necessary, other relevant bodies. ESMA must notify the competent national authorities concerned of the measure it proposes to take. ESMA is also under a duty to review the measures at appropriate intervals that must be at least quarterly.

In 2012, the E.U. adopted a regulation aimed at harmonizing short selling, against the background of the financial crisis. Short selling is a practice consisting in the sale of shares and securities not owned by the vendor at the time of the sale with a view to benefiting from a fall in the price of the shares and securities. In the event of disturbance on the financial markets, the Regulation seeks to prevent an uncontrolled fall in the price of financial instruments as a result of the effect of short selling.

Report of SEC, Fed and other Senior Derivatives Regulators Reveals Deficiency in Financial Firms Measurements of Counterparty Risk

Five years after the financial crisis began a group of global derivatives regulators, including the SEC and the Fed, found that financial firms have made unsatisfactory progress on achieving timely and accurate measures of counterparty risk in derivatives transactions. In a report to the Financial Stability Board, the regulators said that the goal of consistent, timely, and accurate reporting of top counterparty exposures failed to meet both the expectations of regulators and industry best practices. Given the rising need for accurate and timely counterparty data in firms’ own and in regulatory stress-testing plans as well as in other areas of regulation, such as collateral management, the lack of firms’ progress is even more pronounced.

The Senior Supervisors Group includes senior supervisory authorities of major financial services firms in a number of countries, including, in addition to the SEC and the Fed in the U.S., the Prudential Regulation Authority in the U.K. BaFin Germany, the Financial Services Agency in Japan, and the Superintendent of Financial Institutions in Canada.

In a cover letter to FSB Chair Mark Carney, who is also Chair of the Bank of England, Sarah Dahlgren, N.Y. Fed Executive Vice President and Chair of the Senior Supervisors Group, said that the regulators of these financial firms must prioritize the effort within the scope of their own work and commit to impressing upon these firms the importance of being able to quickly and accurately aggregate top counterparty exposures. She added that the counterparty exposure data collection program of the group had two primary aims: 1) to inform regulators of the level of and changes in significant bilateral derivatives and other counterparty exposures; and 2) to enhance the ability of firms to produce accurate and timely counterparty information.

Counterparty reporting for management and supervisors should be the product of standardized, repeatable, and highly automated processes, advised the Group. While some firms have developed their information technology infrastructure to support improved counterparty reporting, noted the report, many still rely on time-consuming and error-prone manual processes. The report also observed that firms should be farther along in their capacity to accurately report risk exposure. While they have improved their data capture systems and can provide more complete and timely data, said the report, data accuracy is still noticeably deficient at many institutions. If firms cannot produce accurate data during relatively benign times, reasoned the Group, they would be unlikely to do so during periods of market stress when exposures could be volatile. Going forward, regulators will expect firms to continue to devote time and attention to the infrastructure necessary to aggregate and update derivatives counterparty exposures accurately and in a timely manner, including the ability to thoroughly review dat quality and trend analysis to identify data anomalies.

Former House and Senate Oversight Chairs urge Supreme Court not to Consider PSLRA as Endorsement of Fraud-on-the-Market Reliance Presumption

Former House and Senate securities oversight chairs and former SEC Chair Chris Cox clarified to the U.S. Supreme Court that the Court should not consider that Congress acquiesced in the fraud-on-the-market presumption of reliance when it passed the Private Securities Litigation Reform Act in 1995. In an amicus brief filed in a case this term challenging the continuing efficacy of the presumption of reliance, the former chairs said that Congressional enactment of the PSLRA did not codify, modify or repeal the fraud-on-the-market presumption of reliance endorsed by the Court in its 1988 ruling in Basic, Inc, v. Levinson 485 U.S. 224. Rather, in enacting the PSLRA, Congress simply left the fate of that judicially-created presumption to a future Congress or to the Court. Thus, amici urged the Court to decide the merits of the challenge to the continued efficacy of the fraud-on-the-market reliance presumption in Halliburton v. Erica P. John Fund, Dkt. No. 13-317, without reference to the PSLRA and any assertion of legislative endorsement or acquiescence.

Amici included, among others, former Senate Banking Committee Chair Al D’Amato (R-NY), former Rep. Michael Oxley (R-OH), Chair of the House Financial Services Committee, former House Energy and Commerce Committee Chairs Tom Bliley (R-VA) and Billy Tauzin (R-LA), former SEC Chair Chris Cox, who was the principal author of the House version of the PSLRA while serving in Congress (R-CA), and former SEC Commissioner Laura Unger, who is a former Counsel to the Senate Banking Committee. Amici were intimately involved in the drafting and enactment of the Private Securities Litigation Reform Act of 1995.

The brief points out that the text of the PSLRA is silent with respect to the element of reliance in a private securities-fraud suit. While the House initially considered undoing Basic’s presumption of reliance, the Senate never voted on any aspect of reliance and the House-Senate conference report did not address the reliance issue. The legislative history indicates that Congress was silent in response to various calls to modify, overturn, or codify the Basic presumption of reliance. The chairs advised the Court not to take this congressional silence as either an implicit acceptance or rejection of Basic’s fraud-on-the-market theory. Legislative inaction is not evidence of acquiescense, contended amici. Moreover, finding such acquiescence would seriously misread the legislative history of the PSLRA and disregard the legislative process. Amici noted that it was particularly reasonable for Congress not to resolve the debate over the Basic presumption, as that doctrine is of judicial origin, not congressional.

Former SEC Commissioners Ask Supreme Court to End Fraud-on-the-Market Reliance Presumption

Four former SEC Commissioners asked the Supreme Court to end the fraud-on-the-market presumption reliance in securities fraud actions that the Court in endorsed in its 1988 decision in Basic, Inc. v. Levinson 485 U.S. 224. In an amicus brief, the former Commissioners said that the Basic opinion effectively dispensed with the element of reliance in defiance of the text of the Securities Exchange Act and its legislative history and in contravention of the consistent holdings of the Court that reliance is required under Section 10(b). They argued that the reliance presumption is a judicially-created presumption tacked on to a judicially-created private right of action with no foundation in the statute’s text and unsupported by legislative history. Yet, in their view, the presumption has become the most powerful engine of civil liability ever established in American law, serving as the foundation of a massive, multibillion-dollar litigation industry.

This outcome has occurred even though the text and structure of the Exchange Act, along with its legislative history, make clear that private plaintiffs in securities fraud actions under Section 10(b) should be required to demonstrate actual reliance. That policy judgment, made explicitly by Congress, should control here, contended the former Commissioners.

Former SEC Commissioners Paul Atkins, Joseph Grundfest, Steven Wallman and Edward Fleischman signed the brief, along with former SEC General Counsel Brian Cartwright. The vehicle for the Court’s review of fraud-on-the-market is Halliburton v. Erica P. John Fund, Dkt. No. 13-317, which is set for oral argument on March 5.

Although the reliance presumption was ostensibly intended to be rebuttable, noted amici, the experience of the past twenty-five years teaches that it is, as a practical matter, irrebuttable, particularly in class actions. The promise that Basic intended the presumption to be rebuttable has failed, said the former SEC officials, and thus Basic has effectively dispensed with the requirement of reliance in Rule 10b-5 actions. A nonrebuttable presumption of reliance has effectively converted Rule 10b–5 into a scheme of investor’s insurance, said amici, a result for which there is no support in the Securities Exchange Act.

The former Commissioners reasoned that the fact that the theoretically rebuttable presumption of reliance is de facto irrebuttable comes from an internal contradiction central to Basic. The majority there admittedly created the presumption in order to facilitate class actions. But rebuttal is an individualized inquiry, noted amici, and, if successful, only bars an individual representative plaintiff from proceeding without proof of reliance. If a proposed class representative happens to be one of the few individual class members as to whom a defendant may be able to defeat the showing of causation, then all that plaintiff’s counsel need do is find a new one. And there will virtually always be another class member as to whom the presumption cannot be rebutted, said the brief, which is why rebuttal is futile in the vast number of cases, and a successful rebuttal will be exceedingly rare.

Tuesday, January 21, 2014

House Panel Examines Proposed SEC Regulations Implementing JOBS Act Crowdfunding Provisions

The House Small Business Committee subcommittee on oversight and regulations examined the SEC proposed regulations implementing the JOBS Act provisions creating a regulated system for equity-based crowdfunding from non-accredited investors. Through this Act, said Subcommittee Chair David Schweikert (R-AZ), Congress intended to lower regulatory barriers in order to give small companies and startups a larger pool of investors from which to raise capital. However, continued the Chair, the SEC did not follow this path.

Rather, the SEC issued complicated proposed rules that impose new compliance, disclosure, and reporting requirements on both small businesses and the online intermediaries that connect investors and entrepreneurs. Some of these provisions are extremely costly for small businesses seeking capital from the crowd, added the Chair. For a startup that has little capital but a promising idea, he noted, the type of businesses for which crowdfunding was designed, having to pay tens of thousands of dollars in compliance costs in order to access capital is an immediate deal-breaker.

Fund Democracy President Mercer Bullard testified that there are many instances  in which  the Commission proposes something  different from the very specific requirements of the JOBS Act. In some cases, the Commission asserts the authority to dilute investor protections, while in other cases to impose additional burdens on small businesses, and in each case its approach would contravene specific directions from Congress.

In his testimony, Daniel Gorfine, Director, Financial Markets Policy at the  Milken Institute urged the SEC to minimize non-statutory disclosure requirements in order to decrease costs and allow the development of crowd-driven vetting mechanisms and criteria. The SEC proposed a number of additional disclosures that go beyond those required by the JOBS Act. While each one in and of itself appears reasonable and intended to provide investors with more information, there are two potential unintended effects.

The first is that in aggregate, together with the statutory disclosure requirements, and a substantial ongoing annual filing requirement regardless of the size of the offering, the overall disclosure and compliance burden for issuers begins to look  significant, especially in light of the relatively small sums of capital that can be raised under Title III crowdfunding. Given the potentially small marginal benefit to investors of requiring startup issuers to provide traditional disclosures required of more mature companies, the additional costs of more disclosure, and significant ongoing reporting, may not be justified.

 The second concern is that too many requirements will inadvertently give unsophisticated investors an artificial sense of comfort with an offering and may blunt the development of crowd-driven investment methods and criteria. Unlike a Reg A filing or a formal public offering registration, Form C will not be reviewed and approved by the SEC, and accordingly should not give investors a false sense that the offering is somehow less risky or not in need of careful vetting.

Monday, January 20, 2014

Dr. King's Legacy Must Be Remembered

I was taking a part of the South to transplant in alien soil. To see if I could respond to the warmth of other suns. Richard Wright

Rosa Parks rode it. Dr. King paved it. It’s cicadas making noise with a Southern Voice. Tim McGraw

In her prize-winning book, ``The Warmth of Other Suns’’ New York Times reporter Isabel Wilkerson details the Great Migration of six million Southern African-Americans to the North and West to escape the segregated South. Because of Dr. Martin Luther King, Jr., who we celebrate today, no one has to seek the warmth of other suns. In fact, there is now occurring a reverse migration back to the South. One of the great achievements of Dr. King is that this civil right revolution was accomplished largely non-violently. In our age of sometimes bitter legislative partisanship, we must remember that Dr. King appealed to our sense of common humanity and a shared sense of social justice. In this 50th anniversary year of the War on Poverty, Dr. King's concern for poverty and the opportunity for all people to rise out of poverty should be remembered. We must never forget his legacy.

E.U. Parliament and Council Agree on Legislation on Derivatives Central Counterparties and Regulating Dark Pools and High Frequency Trading

The European Parliament and the E.U. Council reached an agreement on legislation amending the Markets in Financial Instruments Directive (MiFID) to provide stability and transparency for the financial markets. The new rules will remedy the weaknesses of the financial markets which had become apparent in the worldwide crisis, said European Parliament Rapporteur Markus Ferber MEP-Germany. Commissioner for the Internal Market Michel Barnier said that the legislation is a key step towards establishing a safer, more open and more responsible financial system and restoring investor confidence in the wake of the financial crisis.

The new rules apply to all market operators, such as stock exchanges or other trading platforms, banks, investment companies and funds or other service providers related to financial products. The requirements relate to transparency and investor protection obligations. All market participants get a higher degree of stability and security, from the retail investor to the multinational investment bank, said MEP Ferber.

Excessive downward speculation will be banned under the new MiFID II. The E.U. has ``put the brakes’’ on high-frequency trading , noted MEP Ferber, and unacceptable speculation on food and commodities will also come to an end. The Rapporteur emphasized that it is not in the interest of society as a whole when the price of rice or grain goes up simply because there has been speculation on the markets.

The MiFID is the main piece of E.U. regulation on financial markets. The plenary vote on the MiFID II legislation is expected during the March session of the European Parliament.

U.S. firms. The legislation sets up a harmonized regime for granting access to EU markets for firms from the U.S. and other third countries based on an equivalence assessment of third country jurisdictions by the European Commission. The regime applies only to the cross-border provision of investment services and activities provided to professional and eligible counterparties. For a transitional period of three years, and then pending equivalence decisions by the Commission, national third-country regimes continue to apply.

Dark trading. Dark pools or platforms are where trading interests interact without full pre-trade disclosure to other users or the public. The MiFID II reform means that organized trading of financial instruments must shift to multilateral and well-regulated trading platforms. Strict transparency rules will ensure that dark trading of shares and other equity instruments which undermine efficient and fair price formation will no longer be allowed.

Derivatives. The legislation mandates trading obligations for derivatives that will make trading safer and more efficient and will complement the compulsory clearing requirements under the European Markets Infrastructure Regulation (EMIR). The legislation also sets up a harmonized E.U. system setting limits on the positions held in commodity derivatives, Commissioner Barnier noted, thus MIFID II will contribute to orderly pricing and prevent market abuse, and in turn curb speculation on commodities.

MiFID II provides for enhanced supervisory powers and a harmonized position-limits regime for commodity derivatives to improve transparency, support orderly pricing and prevent market abuse. Under this system competent authorities will impose limits on positions in accordance with a methodology for calculation set by the European Securities and Markets Authority (ESMA).

The legislation also introduces a position-reporting obligation by category of trader. This will help regulators and market participants to have better information on the functioning of these markets.

MiFID II establishes a harmonized E.U. regime for non-discriminatory access to trading venues and central counterparties. Smaller trading venues and newly established central counterparties will benefit from optional transition periods. The non-discriminatory access regime will also apply to benchmarks for trading and clearing purposes. Transitional rules will ensure the smooth application of these provisions.

Investor protection. MiFID II will also strengthen investor protection. Investment firms will have to meet stricter standards to ensure that investors can trust that they are being offered products which are suitable for them and that their assets are well protected. Investors will also be able to rely on independent and neutral advice; and fee and remuneration structures must not conflict with this requirement.

High frequency trading. MiFID II will also ensure that legislation keeps pace with technological developments. The dramatic increase in the speed and volumes of order flows can pose systemic risks. The new rules ensure safe and orderly markets and financial stability through the introduction of trading controls, an appropriate liquidity provision obligation for high-frequency traders pursuing market-making strategies and by regulating the provision of direct electronic market access.

Algorithmic trading is a form of trading where a computer algorithm automatically decides to place an order with minimal or no human intervention. An important form of algorithmic trading is high frequency trading, where a trading system analyzes the market at high speed and then sends large numbers of orders very quickly.

The legislation provides a series of safeguards both on market participants who use algorithms as part of their trading strategies as well as on trading venues where algorithmic and high-frequency trading takes place.

Thus, MiFID II introduces trading controls for algorithmic trading activities which have dramatically increased the speed of trading and can cause systemic risks. These safeguards will include the requirement for all algorithmic traders to be properly regulated and to provide liquidity when pursuing a market-making strategy. In addition, investment firms which provide direct electronic access to a trading venue will be required to have in place systems and risk controls to prevent trading that may contribute to a disorderly market or involve market abuse.

Market structure framework. MiFID II introduces a market structure framework which closes loopholes and ensures that trading, wherever appropriate, takes place on regulated platforms. To this end, it subjects shares to a trading obligation. It further ensures that investment firms operating an internal matching system which executes client orders in shares, depositary receipts, exchange-traded funds, certificates and other similar financial instruments on a multilateral basis have to be authorized as a Multilateral Trading Facility. It also introduces a new multilateral trading venue, the Organized Trading Facility , for non-equity instruments to trade on organized multilateral trading platforms.

These regulations are designed to ensure a level playing field with Regulated Markets and Multilateral Trading Facilities. The neutrality of OTF operators is ensured through restrictions on the use of their own capital, including matched principal trading, and discretion in their execution policy. The legislation introduces a trading obligation for shares as well as a trading obligation for derivatives which are eligible for clearing under the European Markets Infrastructure Regulation (EMIR) and are sufficiently liquid. This will move trading in these instruments onto multilateral and well regulated platforms.

Equity Market Transparency. MIFID II also increases equity market transparency by mandating, for the first time, a principle of transparency for non-equity instruments such as bonds and derivatives. For equities, a double volume cap mechanism limits the use of reference price waivers and negotiated price waivers (4 percent per venue cap and 8 percent global cap) together with a requirement for price improvement at the mid-point for the former.

Large in scale waivers and order management waivers remain the same as under MiFID I. But MiFID II broadens the pre- and post-trade transparency regime to include non-equity instruments, although pre-trade transparency waivers are available for large orders, request for quote and voice trading. Post-trade transparency is provided for all financial instruments with the possibility of deferred publication or volume masking as appropriate.

The legislation also enhances the effective consolidation and disclosure of trading data through the obligation for trading venues to make pre- and post-trade data available on a reasonable commercial basis and through the establishment of a consolidated tape mechanism for post-trade data. These rules are accompanied by the establishment of an approved reporting mechanism and an authorized publication arrangement for trade reporting and publication.

Investor protection. The legislation enhances investor protection by mandating better organizational requirements, such as client asset protection or product governance, which also strengthen the role of management bodies. The new regime also provides for strengthened conduct rules such as an extended scope for the appropriateness tests and reinforced information to clients.

Independent investment advice is clearly distinguished from non-independent advice and limitations are imposed on the receipt of commissions and other inducements. MiFID also introduces harmonized powers and conditions for ESMA to prohibit or restrict the marketing and distribution of certain financial instruments in well-defined circumstances and similar powers for the European Banking Authority in the case of structured deposits. Concerning Packaged Retail Investment Products (PRIPS), the new framework also covers structured deposits and amends the Insurance Mediation Directive to introduce some rules for insurance-based investment products.

Sanctions. The existing regime for effective and harmonized administrative sanctions is also enhanced. The use of criminal sanctions is framed so as to ensure the cooperation between authorities and the transparency of sanctions. A harmonized system of strengthened cooperation will improve the effective detection of breaches of MiFID.

Monday, January 13, 2014

SEC Defends Regulations Implementing Conflict Minerals Provisions of Dodd-Frank Sec. 1502 in DC Circuit Oral Argument

The DC Circuit court of appeals heard oral argument in a case posing a challenge to the SEC regulations implementing the conflict minerals provisions of the Dodd-Frank Act. The regulations are being challenged by a business consortium composed of the National Association of Manufactures, Chamber of Commerce, and Business Roundtable. Section 1502 of the Dodd-Frank Act directs the Commission to issue rules requiring companies to disclose their use of conflict minerals if those minerals are necessary to the functionality or production of a product manufactured by those companies. Under the Act, those minerals include tantalum, tin, gold or tungsten. The argument was heard before a three-judge panel composed of Circuit Judge Srinivasan, Senior Circuit Judge Sentelle, and Senior Circuit Judge Randolph. Peter Keisler argued for the business coalition, while Tracey Hardin argued for the SEC.

Under the final regulations, a company that uses any of the designated minerals would be required to conduct a reasonable good faith country of origin inquiry reasonably designed to determine whether any of its minerals originated in the covered countries or are from scrap or recycled sources. If the inquiry determines that the company knows that the minerals did not originate in the covered countries or are from scrap or recycled sources or the company has no reason to believe that the minerals may have originated in the covered countries and may not be from scrap or recycled sources, then the company must disclose its determination, provide a brief description of the inquiry it undertook and the results of the inquiry on new Form SD filed with the Commission.

The company also would be required to make its description publicly available on its Internet website and provide the Internet address of that site in the Form SD. Under the final regulation, companies that are required to file a Conflict Minerals Report would have to exercise due diligence on the source and chain of custody of their conflict minerals.

The final regulations became effective on November 13, 2012, and the first reports and disclosures it requires are due to be filed with the SEC by May 31, 2014. Ultimately, the Commission declined to adopt any categorical de minimis exception as part of the final rules.

Peter Keisler, counsel for the business group, argued that the SEC has misconstrued the statute. The Commission greatly magnified the cost of the statute by misconstruing Section 1502 and rewriting a crucial standard. Section 1502 uses the language conflict minerals that did originate in the Democratic Republic of the Congo, while the SEC regulations use may have originated. The SEC changed did to may, said counsel. Section 1502 says you have to file a conflict minerals report if the conflict minerals did originate in the DRC, he continued, while the SEC rules say may have originated. Thus, he argued that the mere possibility could trigger may have originated.

Mr. Keisler also contended that a de minimis exception is particularly compelling here, where the application of the rules can impose massive costs without achieving the desired objective, but the SEC said that any de minimis exception would be contrary to the legislative intent. Congress authorized the SEC to grant a de minimis exception, the business coalition advocate noted, and this area cries out for a de minimis exception.

However, on questioning from Senior Circuit Judge Sentelle, counsel conceded that there is no reported case striking down an agency regulation for not including a de minimis exception.

Senior Circuit Judge Randolph pointed out the SEC’s conclusion that small uses of these minerals could be significant. Mr. Keisler argued for a per company de minimis exception as a good solution.

This is a shaming statute, emphasized Mr. Keisler, a ``scarlet letter’’ designed to impact a broader debate. Circuit Judge Srivanasan noted that as a result of the statute, investors are getting information about the company about which they are thinking of investing in.

Tracey Hardin for the SEC noted that the SEC had to make discretionary decisions when implementing Section 1502, adding that the Commission exercised a reasonable interpretation of the statute. The SEC’s reporting trigger is not contrary to the terms of the statute, she said, contending that there is nothing unreasonable about the SEC’s interpretation. The may have originate language triggers an obligation to move on to due diligence.

Section 1502 was silent on how a company determines that its minerals originated in a conflict jurisdiction.

Senior Circuit Judge Sentelle noted that the website posting required by the SEC regulations is a regulation of speech and should not go beyond a statutory requirement just because the Commission thinks Congress wanted this. This is compelled speech.

On Senior Circuit Judge Randolph query on the statutory objective, Ms. Hardin said that the objective of Section 1502 is to promote peace and security in the DRC. It is to increase public awareness of the use of conflict minerals. He questioned how website disclosure would help decrease the use of conflict minerals. Responding to a question on how the SEC will enforce the conflict minerals regulations, SEC counsel said that disclosures will be periodically reviewed. There would be a Rule 10b-5 requirement.

Sunday, January 12, 2014

Praising CFTC-EU Path Forward on Derivatives Regulation, FCA’s Wheatley says Many Details Remain to be Worked Out

There will be a number of regulatory challenges ahead in 2014 around the European Markets Infrastructure Regulation (EMIR), the E.U.’s derivatives regulation regime that is an analog to Title VII of the Dodd-Frank Act, said Martin Wheatley, the Chief Executive of the U.K. Financial Conduct Authority. The cross-border issues associated with derivatives regulation raise the fundamental question of whether regulators should operate independently on global issues so that they can intervene quickly in the national interest, or whether they should find international solutions to international challenges. In remarks at the ICI global trading conference, Mr. Wheatley cautioned that a failure to have cross-border harmonization of derivatives regulation would open the door for regulatory arbitrage; would mean less protection for end-users; and would raise the specter that a participant in the derivatives markets could easily be subject to multiple and different regulatory regimes

The FCA chief praised the CFTC and European Commission for committing to a Path Forward agreement based on mutual recognition and substituted compliance. At the same time, he reminded that the Path Forward remains a roadmap with significant points of detail to work through, particularly details relating to trading venues in the EU and US used by firms in both jurisdictions as major conduits for transatlantic derivatives trading. The FCA, along with the EU, is pushing hard for this approach to be based on mutual recognition of differing regulatory regimes. This calls up the broader issue of the recognition of equivalence between different international regimes. It makes good sense for regulators to accept compliance with foreign rules for cross-border trades, he noted. ESMA has already authorized the first trade repositories under EMIR and, as of the February 12, all derivatives trades, both exchange traded and over-the-counter, falling under the jurisdiction of EMIR will have to be reported to one of ESMA’s recognized trade repositories.

The FCA has started to review firms’ compliance with EMIR in terms of the business conduct regulations already in place, and will also be checking firms’ preparations for the February start date in the coming weeks. He advised firms to ensure that the relevant data is available internally, as well as arranging direct access to a trade repository or delegated reporting facilities. He also encouraged firms to get a legal entity identifier as soon as possible, which should be a relatively quick and straightforward process. This is a vital to the overall success of reporting to trade repositories.

Int’l Accords Needed on Resolution Regimes for Failing SIFIs says German Central Banker

The cross-border consistency of orderly resolution regimes for failing systemically important financial institutions is extremely important in order to end too big to fail and avoid regulatory arbitrage, said Andreas Domfret, a member of the Deutsche Bundesbank executive board.. In remarks at a Euro Finance seminar in Frankfurt am Main, he noted that the new international agreements on resolution regimes developed by the Financial Stability Board are a crucial step. Applying these agreements globally will make the orderly resolution of a systemically important financial institution a more realistic option and thus also a more credible threat.
The FSB set out the key attributes of effective resolution regimes for global financial institutions. The key attributes, which have been endorsed by the United States and other G20 countries, set out the core elements considered to be necessary to make feasible the resolution of financial institutions without severe systemic disruption and without exposing taxpayers to loss, while protecting vital economic functions through mechanisms that make it possible for shareholders and unsecured and uninsured creditors to absorb losses in a manner that respects the hierarchy of claims.
In addition to the FSB initiative, intensive work is being carried out at the European level on the implementation of these principles. For example, negotiations on the European Recovery and Resolution Directive are scheduled for completion by the end of this year. Recently, E.U. Commissioner for the Internal Market Michel Barnier said that completion of the Directive by year-end was possible only if all Member States make compromises. No Member State will get everything it wants in an ideal world, noted the Commissioner.

In Germany, the Bundestag adopted a restructuring act in 2010 which anticipated the European rules. That was followed with the passage of the Act to Strengthen German Financial Supervision in 2012. The legislation embodies a new resolution regime. and also higher capital requirements, or the obligation to trade derivatives via central counterparties, which all represent a distinct improvement on the situation before the failure of Lehman Brothers.

These are all key first steps, noted Mr. Domfret, but they are not enough to make the financial system a safer place. What is needed next is to shape and transpose the new resolution rules agreed by international regulators and authorities consistently across national borders and sectors alike. While conceding that this will not be a simple matter in practice, the central banker emphasized that it is the only way to create a level playing field, prevent regulatory arbitrage, and contain the too-big-to-fail risks.

IASB 2014 Agenda includes Increasing Role for Accounting Standards Advisory Forum

In looking at 2014, IASB Chair Hans Hoogervorst said that the Accounting Standards Advisory Forum (ASAF) will play a critical role in the development and enhancement of IFRS. The Forum has ushered in a new era of enhanced cooperation in standard-setting. In addition, he expects the IFRS Interpretations Committee to play a far more active role with a number of new tools at its disposal. Moreover, the completion of the remaining convergence projects with the FASB will naturally result in IASB technical staff working in a different manner on new agenda projects, noted the Chair, such as the Conceptual Framework and the Disclosure Initiative.

The main goal of the Accounting Standards Advisory Forum to help rationalize and streamline the current complex web of bilateral relationships that the IASB has with National Standard-Setters and regional bodies associated with accounting standard-setting. The FASB is a member of the Forum, along with, among others, the Canadian Accounting Standards Board, the Chinese Accounting Standards Committee and the U.K. Financial Reporting Council.

The IASB also intends to endorse IFRS 9 on accounting for financial instruments in 2014. The financial crisis has driven the IASB to accelerate its work to replace IAS39 with IFRS 9. In the new Standard, the IASB is continuing with a mixed measurement approach, but the Board has tried to put the criteria for classification and measurement on a more objective footing. The classification of a financial instrument depends on both the nature of the cash flows and the business model, explained the Chair. Thus, if an instrument has basic loan features and the business model is to hold it for collection, it is measured at amortized cost. If a financial instrument does not have basic loan features and the business model is to trade the asset, it will be measured at fair value through profit and loss.

IFRS 9 will not drastically change the present situation, he noted, in which most banking assets are carried at cost. But this does not mean that the financial industry can continue to live in the blissful stability provided by amortized cost.

The IASB is currently developing a Discussion Paper on a new macro hedging model. This model will make it possible to better represent in the accounts such risk management activity relating to open portfolios, rather than restricting hedge accounting to specific financial instruments. Accounting for macro hedging would basically make it possible to match the current value of interest rate exposures that are embedded in open portfolios with the fair value of the derivatives that are used to hedge those exposures.

Since it will still take significant time to finalize possible proposals on macro hedging, the Board has separated it from the rest of IFRS 9, which is practically finished and will soon be ready to be endorsed. Because of the significant improvements that IFRS 9 makes in classification and measurement, and also in general hedging and impairment, the IASB Chair has no doubt that it will be endorsed around the world.

E.U. Securities Commissioner Sees China as Partner in Reform of Financial Regulation

Both the European Union and China are singing from the same G20 song book when it comes to the reform of financial regulations in the wake of the global financial crisis, said E.U. Commissioner for the Internal Market Michel Barnier. In recent remarks in Beijing, he noted that the Third Plenum paved the way for reforms for the next ten years. The way in which the announced reforms are implemented in a comprehensive approach will be crucial, not only for China, but for the rest of the world, including Europe.

In recent remarks in Beijing, the Commissioner noted that both China and the E.U. believe that globalization must be organized and needs rules. Similarly, both China and the E.U. consider the G20 as the premier forum. The G20 has been critically important to the development of joint responses to global challenges. Indeed, in the last few years, the commitments made in the G20 have been the roadmap for financial reform and ensuring that every financial product, every market and every activity is suitably regulated.

At its latest summit, the G20 noted that all major jurisdictions have implemented new global capital standards under Basel 3; have completed frameworks for OTC derivatives to be traded on exchanges or electronic trading platforms, centrally cleared, and reported; have identified globally systemically financial institutions and subjected them to heightened prudential standards to mitigate the risks they pose; have set up orderly resolution procedures for large, complex financial institutions without taxpayer loss; and have begun to address potential systemic risks to financial stability emanating from the shadow-banking system.

With regard to financial services, Commissioner Barnier noted that there is a whole body of work to do to implement the rules already agreed upon and to make them work together. It is imperative that both the Chinese and E.U. systems be equally robust so as to avoid a global race to the bottom and the regulatory arbitrage that would ensue. This is especially true with regard to the implementation of the Basel rules and addressing the risks attached to the shadow banking sector.

More broadly, it is important to ensure that market players from one country or region can invest safely in another. Investors must know that their rights will be respected, that they will not be discriminated against as regards the applicable rules; and, where appropriate; that the authorizations obtained at home will be seen as reaching similar outcomes as those in place in the host country.

ESMA Proposes Standards under MiFID on Acquirer of Investment Firm

The European Securities and Markets Authority (ESMA) proposed standards implementing provisions of the Markets in Financial Instruments Directive (MiFID) requiring Member States to make publicly available the information necessary to carry out the assessment of a proposed acquirer of an investment firm. This information, which must be provided by the proposed acquirer at the time of the initial notification, is aimed at ensuring that competent authorities are provided with adequate and proportionate information in order to assess the acquisition.

The proposed standards establish an exhaustive list of information referred to in Article 10b(4) of MiFID and contain standard forms, templates and procedures for the cooperation and exchange of information between the relevant competent authorities as referred to in MiFID. ESMA submitted the draft standards to the European Commission by January 1, 2014. The Commission has three months to decide whether to endorse ESMA’s draft standards.

The main and driving purpose of the proposed draft is to develop an exhaustive list of information to be included by proposed acquirers in their notification to the relevant competent authority. The aim is to set up a harmonized, common list of information that provides legal certainty, clarity and predictability with regard to the assessment process and to the regulatory decision. The proposed standards will comprise clearly specified criteria for the prudential assessment, noted ESMA, which must be applied consistently across Member States.

Senate Bills Aim to Fix Volcker Rule Trust Preferred Securities Write-Down

Senator Mark Kirk (R-IL), along with six other Republican Senators, introduced legislation, S. 1907, to remedy the Volcker Rule’s treatment of debt interests in trust preferred securities by clarifying that the Volcker Rule does not require financial institutions to divest collateralized debt obligations backed by trust preferred securities issued before the date the five financial regulators finalized the Volcker Rule, December 10, 2013. The bill is cosponsored by Senators Mike Crapo (R-ID), Pat Toomey (R-PA), John Barrasso (R-WY), Mike Enzi (R-WY), Jerry Moran (R-KS), and Roger Wicker (R-MS). It is a companion bill to H.R. 3819, which was introduced earlier this week by Rep. Shelley Moore Capito (R-WV), Chair of the House Financial Institutions Subcommittee and full Financial Services Committee Chair Jeb Hensarling (R-TX).

At the same time, Senator Joe Manchin (D-WV), along with Senator Wicker, introduced legislation, S.1912, to address the trust preferred securities issue. The Manchin-Wicker bill applies only to financial institutions with assets of $50 billion or less.

The legislation is needed because, as it stands, the Volcker Rule would require a number of banks to divest their holdings of collateralized debt obligations backed by trust preferred securities and write down these investments under other than temporary impairment according to U.S. GAAP accounting rules, which for many banks could result in a permanent loss of capital.

Senator Crapo, Ranking Member on the Banking Committee, said that one of the first unintended consequences of the Volcker Rule is to force community banks to divest hundreds of millions of dollars at fire sale prices and cause market disruptions in the communities they serve. He described the legislation as a targeted fix providing a simple solution to an accounting problem the financial regulators were unable to resolve in December.

While community banks had been assured that the Volker Rule would not harm or pertain to them, noted Senator Kirk, it was discovered that the final rule contained a provision that unduly and dramatically hurt a number of community banks. In the past, community and regional banks invested in debt tranches including collateralized debt obligations backed by trust preferred securities and collateralized loan obligations to attain access to capital. These instruments, once encouraged by federal financial regulators, are now being scorned and penalized for holding these instruments. Not only were these instruments once encouraged, he said, but also these debt instruments were not the cause of the financial crisis and there was no precursor in the proposed Volcker Rule released by the agencies that these instruments would be so negatively penalized.

Senator Kirk also observed that the issue dealt with by S. 1907 is not a big bank vs. small bank issue. Thus, limiting the size of financial institutions that can qualify for this exemption, as does S. 1912, hurts banks of all sizes. He said that it is inappropriate and inconsistent with the Collins Amendment, codified as Section 165 of the Dodd-Frank Act, which was intended to preserve the community bank trust preferred securities market, if an asset size limit is imposed on the banks investing in collateralized debt obligations backed by trust preferred securities. Imposing such a limit could effectively freeze out an important segment of the investor market, that is financial institutions with greater assets than the asset limit, for collateralized debt obligations holding community bank trust preferred securities.

Sunday, January 05, 2014

Seven U.S. Senators urge SEC to Require Advance Form D Filings to Help State Securities Regulators

Seven U.S. Senators have written to SEC Chair Mary Jo White urging the SEC to require issuers to first submit a Form D filing when public solicitation and advertising are used. If general solicitation or advertising is not used, then the current 15 day post-first sale filing deadline would still apply. The Senators said that the advance filing of Form D will be especially helpful to state securities regulators. Currently, a Form D is not required to be filed until l5 days after a Rule 506(c) offering has commenced. In light of the lifting of the ban on general solicitation in Regulation D offerings, the Commission's proposes to require issuers to file an Advance Form D before a general solicitation offering commences. The Senators strongly urge that this requirement be adopted. Signing the letter to Chair White were Senators Carl Levin (D-MI), Martin Heinrich (D-NM), Tom Harkin (D-IA), Jack Reed (D-RI), Mark Pryor (D-AR), Jeff Merkley (D-OR) and Angus King (I-ME).

Although the Rule 506 exemption is used successfully by many legitimate issuers, they noted, the exemption has also become an attractive option for individuals who would otherwise be prohibited from engaging in the securities business, and in some cases, operates as a haven for fraud.

State securities regulators are the primary regulator of offerings conducted under Rule 506 pursuant to their antifraud authority.This front-line regulatory protection is critical, said the Senators, particularly given that the SEC does not actively monitor Rule 506 offerings and is not likely to scrutinize the tide of general solicitations or advertisements that will stem from implementation of Title II of the JOBS Act. Prior to removal of the long-standing ban on general solicitation and advertising, state securities investigators could be assured that any securities offering relying on general solicitation was registered with the SEC if it was publicly advertised on the internet or elsewhere. State securities regulators commonly encourage investors in their states to investigate before they invest.

Typically this results in communications by state regulators with investors, notably, many local "mom and pop" investors, who are seeking information about issuers and potential investments. With the removal of the general solicitation and advertising prohibition, a state investigator will not be able to determine whether the issuer is advertising an unregistered, and non-exempt, offering to the general public or engaging in a compliant Rule 506 offering.

In their view, requiring advance filing of a Form D will address the practical realities that will now be faced by state enforcement personnel. Simply requiring a Form D filing prior to any public solicitation or advertising will ensure that state securities regulators, and the SEC, will be able to determine an issuer's intent to rely on general solicitation and advertising, it will enable state regulators to respond to questions from investors in their states about publicly advertised offerings, and it will further enable local investors, who can also access Form D filings, to get basic background information about legitimate offerings before they invest.

ESMA Names New Securities Markets Stakeholder Group

The European Securities and Markets Authority (ESMA) has named a new Securities Markets Stakeholder Group composed of 30 individuals drawn from across 17 Member States. The Gorup represents ESMA’s key stakeholder constituencies of consumer representatives; users of financial services; financial market participants; employees of financial institution and small and medium sized enterprises; and academics.

The Stakeholder Group was set up to facilitate consultation with key financial market stakeholders on all aspects of ESMA’s work. It provides ESMA with opinions and advice on policy workstreams and must be consulted on technical standards and guidelines and recommendations. In addition, the Stakeholder Group is expected to notify ESMA of any inconsistent application of European Union law as well as inconsistent supervisory practices in the Member States. ESMA Chair Steven Maijoor has noted that the Group makes an important contribution to ESMA’s policy development by providing timely and valuable input on how ESMA regulations may potentially affect the different users of financial markets.

House Leaders Circulate Draft Legislation to End Duplicative and Outdated Regulations

House Financial Institutions Subcommittee Chair Shelley Moore Capito (R-WV) and Ranking Member Gregory Meeks (D-NY) are circulating a discussion draft of bi-partisan legislation that would ensure that conflicting, inconsistent, duplicative or outdated regulations are regularly identified and addressed in order to reduce unwarranted regulatory burdens on financial institutions. The legislation would provide that, before issuing a rule or order, the SEC, the CFTC, the FDIC, the OCC, the CFPB and the Federal Reserve Board  would be required to consider the interaction between the proposed rule or order and existing federal regulations and orders, with a specific focus on whether the rule or order is in conflict with, inconsistent with, or duplicative of existing federal regulations and orders; and whether existing federal regulations and orders are outdated.

Under the measure, regulators would be required to take all available measures to resolve any duplicative or inconsistent existing regulation or order before issuing a final regulation or order. Finally, each regulator would be required to submit to Congress, within 60 days of making a determination, a report with recommendations of any federal laws or regulations that should be repealed or amended in order to resolve conflicting, inconsistent, duplicative or outdated laws and regulations