Bridging the Week by Gary DeWaal: November 3 to 7 and November 10, 2014 (Tweaking, Residual Interest; CFTC Priorities; Enforcement Highlights; G-IBs; Stress Tests)

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Published Date: November 09, 2014

The 30th Annual Futures Industry Association Futures and Options Expo may have occupied the main stage in Chicago last week, but continued preparation for the rollout of new futures-industry rules—including, principally, important measures involving the protection of customer funds—as well as new proposed tweaks to previously adopted old rules, occupied the day-to-day plate of many remaining back at the office. As a result, futures industry themes dominated the financial industry landscape last week, but large banks were also told they could not get significantly larger, and one Fed governor proposed the implementation of standardized stress tests to help ensure the critical reliability of clearinghouses.

As a result, the following matters are covered in this week’s Bridging the Week:

Video Version:

Article Version:

CFTC Proposes a Cornucopia of Measures to Avoid Unintended Consequences

At a public hearing on November 3, the Commodity Futures Trading Commission proposed three measures intended to avoid unintended consequences arising from previously adopted rules. These proposals were to:

According to Timothy Massad, CFTC Chairman, these measures, if approved, will “involve fining tuning our rules to make sure they work as intended.”

In recommending issuance of the proposal to delay the automatic change in time FCMs are required to contribute residual interest, Commissioner Mark Wetjen appeared to acknowledge the challenging economic situation many FCMs currently face. According to Mr. Wetjen,

[c]learly, while the commission must weigh the costs to FCMs of its risk-management requirements, it need not scope them to ensure that every FCM that exists today has systems and practices in place to comply with them. Going forward, the commission should strive to ensure adequate accessibility to the marketplace knowing its importance to market liquidity, but remain vigilant in enforcing current FCM requirements under its rules.

Commissioner J. Christopher Giancarlo, in his opening remarks, more expressly acknowledged the financial plight of many FCMs and the impact on them of more CFTC rules.

Without healthy FCMs serving their customers, the everyday costs of groceries and winter heating fuel will rise for American families. Yet, today we have around half the number of FCMs serving our farmers than we did a few years ago. FCMs, particularly small FCMs, are being squeezed by the current environment of low interest rates and increased regulatory burdens. They are barely breaking even. We should not be squeezing them further with increased compliance costs if we can avoid it and still effectively oversee the markets.

Mr. Giancarlo also argued that, not only should the automatic change in time provision related to residual interest be cancelled, as proposed, but other automatic provisions in CFTC rules too—such as the automatic lowering of the de minimis threshold to become a swap dealer from US $8 billion to $3 billion in 2016. “Like today’s proposal, the Commission should only adjust the de minimis threshold after it has considered the data and weighed public comments,” said Mr. Giancarlo.

Proposed rules regarding residual interest and recordkeeping were issued the day of the hearing. Comments will be due by 60 days after formal publication in the Federal Register.

(Click here for more information on the CFTC’s residual interest proposal in the article “CFTC Proposes to Revise Residual Interest Deadline for FCMs” and here for more information on the Commission’s recordkeeping proposal in the article “CFTC Proposes to Amend Recordkeeping Requirements,” both in the November 7 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)

My View: The political landscape will change radically in January as a result of the election this past week. Although some might hope that the Dodd-Frank Wall Street Reform and Consumer Protection Act might be repealed, it won’t be. However, it is possible that, to avoid the possibility of endless hearings on the Hill as well as a nod to political reality, the Commission will continue its new path of tweaking existing regulations to minimize unintended (if not foreseen) consequences. The Commission also needs to rely on the self-regulatory organizations more—even for the enforcement of some market offenses—to ensure it has the resources to address what it considers its priority issues. Finally, the Commission should consider periodically and formally identifying and issuing a proposed schedule of its anticipated initiatives—such as the likely timing of its re-release of its position limits rule.

Joint Audit Committee Issues Reminders of Residual Interest Requirements in Advance of November 14 Rollout; Clarifies Limitations on Trading While Undermargined

In advance of new customer funds protection measures effective November 14, the Joint Audit Committee issued two regulatory alerts that provide helpful guidance regarding FCMs’ new requirements to:

The JAC also clarified that an FCM may continue legally to accept orders that don’t solely reduce the risk of existing positions while an account is undermargined or in debit for a reasonable time period. A reasonable time is less than five business days for customer accounts and four business days for non-customer and omnibus accounts. An FCM, however, may impose stricter requirements.

The customer account origins impacted by the new residual interest requirement are those related to the trading of domestic futures and options (1.22 segregated environment) and those related to the trading of non-US futures and options (30.7 secured environment). A different customer funds protection regime for cleared swaps was inaugurated in November 2012 known as LSOC (legally segregated, operationally commingled). (Click here for a helpful guide to customer funds protection published by the Futures Industry Association, last updated in May 2014.)

As part of its guidance, the JAC reminded FCMs of their obligation to provide immediate notice to the Commodity Futures Trading Commission and their designated self-regulatory organization if the amount of their segregated or secured residual interest is less than their requirements at the 6 p.m. deadline. If an FCM is also a Securities and Exchange Commission registered broker-dealer, it must also provide notice to the SEC.

The JAC also provided guidance on when an FCM may consider that it has received a customer’s funds in connection with payments by check, Automated Clearing House processes or foreign currency transfers.

And briefly:

Compliance Weeds: As I wrote just a few weeks ago, “[a]lthough it is easy to view a regulator’s report of its enforcement accomplishments with a bit of cynicism, such reports are very useful summaries of a regulator’s priorities and should be used as checklists to help registrants double check their policies and procedures to ensure they are adequately addressing a regulator’s principal concerns.” (Click here to see my full commentary on this subject in the article “Priorities Emerge in SEC Enforcement’s Look Back at 2014 Activities,” in the October 13 to 17 and 20, 2014 edition of Bridging the Week.) Also, in order to save expense and time for both the industry and itself, the CFTC should consider enacting a formal policy to offer potential respondents an opportunity to settle enforcement matters related to certain types of offenses for a nominal fine in an expedited process where no customer has been harmed and the potential respondent (1) promptly self reports the offense (excluding offenses involving fraud or manipulation); (2) promptly corrects the offense; (3) voluntarily retains the assistance of a third-party consultant to make recommendations to avoid future, similar violations; and (4) agrees materially to implement such consultant’s recommendations on a timely basis. The CFTC’s Division of Enforcement could institute this policy by revising its Enforcement Advisory “Cooperation Factors in Enforcement Division Sanction Recommendations,” that have not been updated since 2007 (click here to access).

Guest Commentary: The letter to the FSB identifies some legitimate causes for concern about a relatively new tactic being used by regulators to manage systemic risk arising from derivatives. This technique involves requiring or persuading entities they regulate to force counterparties they do not regulate to accept contractual limits on their rights to terminate swaps following the insolvency of a financial institution. Promoting the orderly unwinding of financial institutions is certainly a desirable goal, but this tactic inevitably raises questions about the extent to which the ends justify the means. The trade associations make the fair point that, from both a policy and a process perspective, use of this tactic may lead to a sub-optimal outcome compared to achieving the desired goal through changes in insolvency laws.

And even more briefly:

For more information, see:

CFTC Extends Duration of Relief for Certain Affiliated Counterparties’ Swaps Transactions:

CFTC Grants Relief to G-IB to Execute and Give-Up Trades to Non-Guarantor FCM:

CFTC Proposes a Cornucopia of Measures to Avoid Unintended Consequences:

CFTC Reminisces Over 2014 Enforcement Highlights:

Fed Governor Calls for Stress Testing Clearinghouses:

FSB Issues Report Cards on Rollout of OTC Derivatives Market Reforms and Jurisdictions’ Adoption of Bank Compensation Reform Practices:

OTC Market Reforms:
Compensation Reforms:

ICE Benchmark Administration to Administer Gold Price Benchmark:

Joint Audit Committee Issues Reminders of Residual Interest Requirements in Advance of November 14 Rollout; Clarifies Limitations on Trading While Undermargined:

Residual Interest and Undermargined Capital Charge:
Undermargined Trading Requirements:

Large Banks Impeded From Getting Larger by New Fed Rule:

MFA Argues Against Subjecting NDFs to Mandatory European Clearing at This Time:

OTC Derivatives Regulators Self-Assess Progress of Resolving Cross-Border Implementation Issues:

SEC Fines 13 Firms for Selling Puerto Rico Junk Bonds to Retail Investors in Less Than Minimum Increments:

Representative cases:

Six Industry Organizations Urge FSB to Stop Promoting Potential Suspension of Counterparties’ Early Termination Rights in US Bankruptcy Actions:

Two New CFTC Commissioners Provide Insight Into Priorities at FIA Expo:

Sharon Bowen:
Timothy Massad:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of November 8, 2014. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP and/or Gary DeWaal may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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