Bridging the Week by Gary DeWaal: June 8 to 12 and 15, 2015 (Fair and Effective Markets, ALJs Unconstitutional, Europe’s More Extensive Position Limits)

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Published Date: June 14, 2015

A US federal court in Georgia enjoined an administrative enforcement hearing brought by the Securities and Exchange Commission on the grounds that the administrative law judge was appointed in an unconstitutional manner. On the other side of the Atlantic Ocean, the executive director of the European Securities and Markets Authority seemed to suggest that there was at least one important difference in the approach of the Commodity Futures Trading Commission and the European Commission in overseeing clearinghouses that could derail a necessary determination by the EC to avoid onerous capital charges by European banks clearing through US clearinghouses. As a result, the following matters are covered in this week’s Bridging the Week:

Video Version:

Article Version:

UK Fair and Effective Markets Review Calls for Upping the Standards in UK and Global Fixed Income, Currency and Commodity Markets:

The Fair and Effective Markets Review issued 21 recommendations to “restore trust” in the institutionally traded fixed income, currency and commodity markets in the United Kingdom and globally. Among other things, the Review recommended raising the standards, professionalism and accountability of persons involved in FICC markets; strengthening regulations of FICC markets in the United Kingdom; and promoting fairer FICC market structures by increasing transparency and acting on anti-competitive structures or behaviors.

The Review was established by the Chancellor of the Exchequer and the Bank of England in June 2014. The Review was co-chaired by representatives of the BoE, the Financial Conduct Authority and Her Majesty’s Treasury.

The goal of the Review was to help restore public confidence in FICC markets. According to the Review, FICC markets have not worked well in recent years:

Attempted manipulation of benchmarks and market prices, misuse of confidential information, misrepresentation to clients and attempted collusion have led to huge fines, reputational damage, diversion of management resources and the reining in of productive risk taking. Market effectiveness has been impaired. And public trust has been severely damaged. Repeated attempts to draw a line under the issue have been undermined as further instances of past misconduct have come to light — something that continued during the life of this Review.

To achieve its objectives, the Review recommended that, among other measures, (1) the International Organization of Securities Commissions consider developing a set of trading practices standards that would apply across global FICC markets; (2) potential UK criminal sanctions for market abuse be increased; (3) qualification standards be required for market participants; and (4) public disclosure regarding participants’ disciplinary actions be enhanced “to avoid misconduct going undetected when individuals change jobs.”

The Review also suggested that there should be an examination of pay practices “to improve the alignment between remuneration and conduct risk at a global level.”

The Review extensively discussed the impact of algorithmic trading on FICC markets and observed some of the benefits as well as potential misconduct that may arise from its use. According to the Review,

Algorithmic trading may reduce the scope for misconduct along one dimension (by reducing the scope for human discretion in trading decisions) but may also create risks to the effectiveness of markets … No market structure could reasonably have expected to emerge unscathed from the volatility that followed the Swiss National Bank’s removal of the Swiss franc peg in January 2015. But the response of the FX markets nonetheless highlighted some of the ways in which the authorities’ understanding of market behaviour is likely to have to adjust with the increased use of electronic trading strategies…

Specifically, the Review expressed concerns about barriers to entry because of the costs of new technologies, and the proliferation of order types and related incentive fees that may encourage certain behaviors that are inconsistent with fair and effective markets “and may create a scope for misconduct.”

Other behaviors the Review identified as inconsistent with fair and effective markets included manipulation or seeking to mislead market participants; trading that endeavors to provide misleading impressions regarding available supply or demand; spreading rumors; improperly disclosing or trading on the basis of market sensitive information; misusing client confidential information; and front running client orders.

To elevate professional standards in FICC markets, the Review suggested implementing a training and qualification scheme similar to that currently imposed by the Financial Industry Regulatory Authority for all security professionals in the United States (i.e., requiring a Series 7 examination). The Review also recommended that firms heighten their automated surveillance of their employees’ FICC markets activities, and that regulators incentivize firms “to remedy conduct failures voluntarily and as early as possible.” The Review provided examples from the FCA’s own regulatory toolkit as examples of the type of encouragements a regulator might provide (e.g., requiring appointment of a so-called “skilled person” to obtain an independent view of a firm’s activities, and varying authorizations of the types of business in which a firm may engage).

According to the Review, public confidence in FICC markets will be restored when they are seen as fair and effective. By fair, the Review means the markets have “clear, proportionate and consistently applied” standards of conduct; are sufficiently transparent to ensure participants can evaluate whether the standards are consistently applied; are open to all; allow participants to compete based on merit; and “provide confidence” that market participants act with integrity. Markets are effective, says the Review, when they allow end user participation in a “predictable way;” are sufficiently liquid and supported by good post-trade infrastructure to permit participants to source liquidity; allow participants to trade at competitive prices; and ensure a “proper allocation of capital and risk.”

It is anticipated that the Review’s chairs will provide a report on the implementation of the Review’s recommendation by June 2016. (Click here for further background on the Review in the article, "UK Authorities Publish Fair and Effective Markets Review Final Report" in the June 12, 2015 edition of Corporate & Financial Weekly Digest by Katten Muchin Rosenman LLP.)

My View: The Fair and Effective Markets Review provides a thoughtful review of current and developing business practices in fixed income, currency and commodity markets, and one would have to be living in a cave isolated from all human contact not to think that there are at least some aspects of conduct associated with these markets that need to be improved. If there is any lingering doubt, just glance at some of the electronic communications among traders recently cited in connection with the $3.4 billion of fines doled out against five of the world’s largest banks related to allegations that they manipulated prices in the foreign exchange markets. However, the solutions suggested by the Review – that more regulation and controls will solve the problem – are not necessarily the answer. The issue is not quantity, it’s quality. Since the 2008-2009 financial crisis, regulators have already been prescribing too many detailed solutions that are doing more to create a check the box approach to compliance among market participants – just to stay out of regulatory trouble – rather than encouraging a holistic examination of how best to improve overall culture. The price inevitably will be a less ingrained change in attitude and more and more additional costs that will drive at least some market players from business and decrease market efficiency. Regulators and market participants need to work together to help address identified problems and devise practical solutions that more effectively modify culture while enhancing market liquidity, not just add more requirements.


Legal Weeds: If upheld by appeals courts, including the Supreme Court, the Georgia court’s decision could raise important questions regarding the legitimacy of past decisions by both SEC and Commodity Futures Trading Commission ALJs. This constitutional argument could likely be next addressed by a federal court in New York. There, Lynn Tilton is currently seeking to enjoin the agency from proceeding with administrative enforcement proceeding against her and companies she owns and controls. The SEC alleged that, since 2003, the respondents misled investors about the declining value of assets in collateralized loan obligation funds they managed. (Click here for more details regarding this litigation in the article, “SEC Charges Investment Advisers and Owner of Misleading Investors in Funds Regarding the Poor Performance of Underlying Assets; Respondents Sue SEC Right Back” in the April 5, 2015 edition of Bridging the Week.)

My View: Recent public comments by CFTC Chairman Timothy Massad and Jonathan Hill, European Union Commissioner for Financial Stability, and the extension by the European Commission of the effective date of potentially onerous capital charges for European banks clearing US clearinghouses until December 15, 2015, seemed to suggest that cooler heads were prevailing in the debate over whose margin system was better. In fact, a possible consensus appeared to be developing that both the EC and US margin regimes provided equivalent protections. Hopefully, Ms. Ross’s comments do not suggest that the European Commission now requires the United States to show that its margin regime is precisely identical or tougher than that in the European Union in order for US clearinghouses to be deemed subject to equivalent oversight as EU clearinghouses. This should not be a competition!

Compliance Weeds: Firms that may be impacted by European position limits in commodity derivatives should be closely following not only proposed reporting requirements and position limits generally under MiFID II and MiFIR, but reporting requirements and position limits that already are being enacted by some member states (see next article). MiFID II and MiFIR are scheduled to go into effect on January 3, 2017. Click here for an overview of MiFID II and MiFIR in the article “European Parliament Takes Further Step to Increase Requirements for Trading Venues and Algorithmic Trading, and to Introduce Commodity Position Limits in Europe” in the April 16, 2014 edition of Between Bridges.)

And even more briefly:

For more information, see:

Canadian Trader Sued by SEC for Short-Selling Violations in Connection With Follow-Up Offerings:

Discussion of Proposed Settlement:

Countries Receive Second Report Card on First Round of PFMI Implementation; US Continues to Lag Behind:

ESMA Executive Director Encourages CFTC to Reconsider Opposition to Two-Day Cover at CCPs for House Positions of Clearing Members; Provides Preview of European Position Limits Regime:

FIA Global Launches CCP Comparative Risk Assessment Tool:

France Rolls Out Reporting and Position Limit Regime for Agricultural Commodity Derivatives Beginning July 1:

Georgia Federal Court Holds SEC Administrative Proceeding Unconstitutional:

Korean FSC Liberalizes Regulations on Financial Institutions Outsourcing Data Processing and IT Facilities:

Minneapolis Grain Exchange Receives High Grades in CFTC Rule Enforcement Review:

Regarding Uncleared Swaps Margin, CFTC Chairman Proposes Hybrid Approach for Non-US Swap Dealers While European Supervisory Authorities Commence Consultation:

Chairman Massad Comments:
ESA Consultation:

SEC Seeks Comment on Certain Exchange-Traded Products, Including ETFs:

UK Fair and Effective Markets Review Calls For Upping the Standards in UK and Global Fixed Income, Currency and Commodity Markets:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of June 13, 2015. 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 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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