Insights from Winston & Strawn

At a speech to the Asian Financial Forum, in Hong Kong, on January 18, 2016, the European Securities and Markets Authority Chair, Steven Maijoor, focused on the financial markets and the new normal monetary policy. Mr. Maijoor highlighted that the world tends to forget that the persistence of low interest rates is not normal in the economy. He pointed out that the abnormally low interest rates have had an impact on the financial markets and more specifically the (i) investor behavior, (ii) liquidity, and (iii) the role of the non-banking sector in general.

On investor behavior, Mr. Maijoor noted that low interest rates imply “cheap money” and as a result investor appetites are increased and their discipline is reduced “in undertaking appropriate assessments of the risks to their investment.” Second, low interest rates have had significant impact on liquidity in financial markets. While Mr. Maijoor does not deny that other players such as technology, competition, and regulation have played a role, he does highlight that there are concerns on the current levels of liquidity. Finally, low interest rates and the scarce supply of bank funding are a catalyst to the expansion of the non-banking sector.

Mr. Maijoor concluded his speech with a future thinking approach, noting that changes to the monetary policy are around the corner, which will hopefully reduce the three risks he mentions and create a more balanced financial system that happens to also be more stable. As such, he employed the terms “normalized interest rates” and market “transparency” which he found to be necessary in achieving this type of a strong financial market.

While time will be the only measure on whether his vision is achievable, it is hard to look away from articles pointing out that Citigroup’s Mr. Willem Buiter noted that the low interest rates would last for years, and as a result there are buoying sales of luxury cars in Australia.

Feature: Shadow Banking

U.S. and global regulators continue to cast a watchful eye upon the shadow banking system as commentators raise questions about the system’s potential threat to financial stability. Bloomberg’s editorial board views the recent trouble experienced by some mutual funds in meeting investor redemptions as a “test” of the shadow banking system, noting that while the repercussions of failed mutual funds may be limited, other shadow banking entities with activity in other markets may hold risky corporate debt as well, allowing a greater chance for that risk to spread throughout the financial system. Last month, Federal Reserve Vice Chair Stanley Fischer delivered a speech in which he emphasized the dangers posed by a lack of data about shadow banking activities. He argued that data gaps interfere with regulators’ ability to design effective regulation and warned that “what you do not know really can hurt you–and there remains a good bit we do not know.” And financial analyst Scott Peng, in a recent blog post for Institutional Investor, maintained that the prevalence of shadow banking in the U.S. could have ramifications for the national economy if investors decide to liquidate investments, concluding that “an economy that is highly reliant on the shadow banking system is exposed to risks similar to those of a bank exposed to excessive wholesale funding: a greater likelihood of liquidity runs, increased funding volatility and gaps in credit provision.”

The renewed calls for alarm regarding the shadow banking system come on the heels of a series of reports published by the Financial Stability Board (“FSB”). Last fall, the FSB’s Regional Consultative Group for the Americas released the second report from its Working Group on Shadow Banking, which provides the findings from the Group’s shadow banking monitoring exercise that seeks to shed light on shadow banking activities in the region. Just two weeks later, the FSB published its fifth annual Global Shadow Banking Monitoring Report, which tracks shadow banking activities in 26 jurisdictions and the entire euro area to assist regulators in identifying emerging systemic risks. The report indicated that global shadow banking assets grew to $36 trillion, with over 80 percent of those assets residing in North America, Asia and northern Europe. An article inBloomberg pointed out that the growth in global shadow banking assets was driven primarily by emerging markets, and particularly by China. Federal Reserve analyst Nicholas Borst notes in a blog post written for the Federal Reserve Bank of San Francisco that the growth in shadow banking in China and other Asian countries reflects an increasingly important role for the region’s shadow banking, which will likely attract heightened scrutiny from the FSB.

Alongside the Global Shadow Banking Monitoring Report, the FSB published two additional documents on its regulatory approach to shadow banking. The FSB’s report on transforming shadow banking into resilient market-based finance provides an update on the progress of the FSB’s two-pronged approach to address financial stability risks in the shadow banking system, which includes creating a framework for monitoring shadow banking activities and developing policies to bolster oversight and regulation. The report notes that over the past year progress has been made to implement policies to strengthen oversight of shadow banking, especially in the area of securities financing. To illustrate these efforts, the FSB also published a document that establishes the final policy recommendations for a regulatory framework for haircuts on non-centrally cleared securities transactions. The framework applies to those transactions in which financing against collateral other than government securities is provided to non-banks by other non-banks and is designed to limit the build-up of excessive leverage outside the banking system. The implementation date for the numerical haircut floors has been extended until the end of 2018 to allow jurisdictions to adopt market regulation that may be required to implement the floors.

It appears that regulators around the globe are following the FSB’s lead. The Wall Street Journal reported on January 10th that the Federal Reserve is developing its own proposed rules to set margin requirements for securities financing transactions.  The article notes that an agreement among 25 global regulators to adopt the FSB’s recommendations for haircuts on non-centrally cleared securities transactions has emboldened the Federal Reserve to consider the new margin requirements, which would apply to all financial firms, because it has reduced the threat of financial firms moving transactions overseas to avoid stricter rules implemented by the Federal Reserve.

European regulators are also moving forward with plans for additional regulation of shadow banking. On January 12th, new E.U. rules became effective that will require additional reporting and disclosure requirements for securities financing transactions. Under the new rules, all securities financing transactions, with the exception of those concluded with central banks, will be required to be reported to trade repositories. In addition, investment funds will be required to provide reports to investors that disclose information about their use of securities financing transactions and total return swaps. The new rules also establish disclosure requirements regarding the reuse of collateral. The new rules reflect a commitment by regulators to increase transparency in the shadow banking sector.

The European Banking Authority (“EBA”) also finalized Guidelines for regulated E.U. institutions to establish internal limits for their individual and aggregate exposures to shadow banking entities to assist institutions in limiting the risks that accompany these exposures. Among other things, the Guidelines require institutions to establish an internal framework for identifying, managing, and mitigating the risks related to their exposures to shadow banking entities based on defined analyses by risk officers and to implement a process for determining the interconnectedness between shadow banking entities and the institution. The Guidelines will apply to shadow banking exposures with an exposure value of 0.25 percent or more of the institution’s eligible capital, which reflects the EBA’s decision to introduce more flexibility in the Guidelines and prevent “strangling” shadow banking as a viable source of funding, according to a report in Reuters. The Guidelines will go into effect on January 1, 2017.

The Basel Committee on Banking Supervision has proposed an additional measure to shield banks from the potential risks posed by their relationships with shadow banks. In a consultative document released last month, the Basel Committee set out proposals for an approach for identifying, assessing, and addressing step-in risk in a bank’s relationship with shadow banking entities, which is the risk that a bank may provide financial support to a shadow bank in financial stress that goes beyond its contractual obligations. The proposals also include approaches that could be applied to prudential measures to address step-in risk. Comments on the proposals should be submitted on or before March 17, 2016.

The increased scrutiny of shadow banking has some observers raising other concerns: Fitch Ratings anticipates that shadow banking growth will start to slow this year under the burden of heightened regulation and increased competition from banks. Whether or not this prediction bears out, shadow banks will continue to attract attention in 2016, as regulators more carefully examine the industry to readily expose its risks and activities.

Banking Agency Developments


OCC Publishes Interagency Advisory on External Audits of Internationally Active U.S. Financial Institutions

On January 15th, the Office of the Comptroller of the Currency (“OCC”), along with the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation (“the agencies”) issued an advisory to indicate their support for the principles and expectations set forth in the March 2014 Basel Committee on Banking Supervision supervisory guidance on external audits of banks. OCC Bulletin.

Federal Reserve

FRB Announces its Income and Expense Data and Transfers to the Treasury for 2015

On January 11th, the Federal Reserve Board (“FRB”) announced preliminary results indicating that the Reserve Banks provided for payments of approximately $97.7 billion of their estimated 2015 net income to the U.S. Treasury. In addition, the Federal Reserve transferred to the Treasury $19.3 billion from Reserve Bank capital surplus on December 28, 2015, the amount necessary to reduce aggregate Reserve Bank surplus to the $10 billion surplus limitation in the Fixing America’s Surface Transportation Act (“FAST Act”). The 2015 audited Reserve Bank financial statements are expected to be published in March and may include adjustments to these preliminary unaudited results. Federal Reserve Board Press Release.

Securities and Exchange Commission

Interim Final Rules and Requests for Comment

SEC Approves Interim Final Rules Implementing FAST Act Changes to Financial Reporting Forms

The Securities and Exchange Commission (“SEC”) adopted interim final rules on January 13th to implement provisions of the FAST Act that mandate changes to two financial reporting forms for emerging growth companies and smaller reporting companies. The rules revise Forms S-1 and F-1 to allow emerging growth companies that include all required financial information on their registration statements at the time of an offering to omit certain historical period financial information prior to the offering. The rules also modify Form S-1 to permit smaller reporting companies to use incorporation by reference for future filings after the registration statement becomes effective. The interim final rules will become effective upon publication in the Federal Register. The interim final rules also request comment on whether the rules should be extended to other registrants or forms. Comments should be submitted within 30 days of publication in the Federal Register. SEC Press Release.


Division of Investment Management Updates Money Market Fund FAQs

The SEC’s Division of Investment Management published an updated version of its Money Market Fund Reform Frequently Asked Questions on January 13th. The updated FAQs include new information regarding required disclosures on Form N-CR, required website disclosures, money market fund advertisements, and government money market funds. Money Market Fund Reform FAQs.

Prepaid Tuition Programs May Be Treated as Qualified Institutional Buyers and Accredited Investors

The SEC’s Division of Corporation Finance responded on January 12th to a request for interpretive guidance by the College Savings Plans Network on behalf of eleven state-operated Section 529 prepaid tuition programs regarding whether the programs qualify as qualified institutional buyers under Rule 144A and accredited investors under Rule 501(a)(3) of Regulation D. The Division concluded that the tuition programs may be treated as qualified institutional buyers and as accredited investors as long as they satisfy the other requirements of these definitions as set out in Rule 144A and Rule 501(a)(3) of Regulation D. SEC No-Action Letter.

Other Developments

Equity Market Structure Advisory Committee Meeting

The SEC announced that its Equity Market Structure Advisory Committee will meet on February 2, 2016, to discuss the events of August 24, 2015, and other issues affecting customers in the current equity market structure. The SEC invites the public to submit written statements in advance of the public meeting, which should be submitted on or before January 27, 2016.

SEC Approves Whistleblower Award Claim by Company Outsider Who Provided Detailed Analysis

The SEC announced on January 15th that it has granted a whistleblower award of over $700,000 to a company outsider who provided the SEC with a detailed, independent analysis that resulted in a successful SEC enforcement action. SEC Commission Notice 34-76921.

Private Fund Statistics

The SEC’s Division of Investment Management published Private Fund Statistics for the first quarter of 2015, the second quarter of 2015, and revised statistics for the fourth quarter of 2014.

SEC Highlights New Areas of Focus for 2016 Examination Priorities

The SEC revealed the 2016 examination priorities for its Office of Compliance Inspections and Examinations (“OCIE”) in an announcement on January 11th. New areas of focus for 2016 include liquidity controls, public pension advisers, product promotion, exchange-traded funds, and variable annuities. The SEC indicated that the OCIE will continue to pursue some 2015 initiatives as well, including a focus on risks to investors seeking retirement planning information, advice, products, and services; cyber security controls at broker-dealers and investment advisers; and data analytics to assess anti-money laundering compliance, microcap fraud, and excessive trading. SEC Press Release.

Staff Announcements

The SEC announced on January 11th that Julie M. Riewe, Co-Chief of the Enforcement Division’s Asset Management Unit, will depart the agency next month. During her tenure at the SEC, Riewe was responsible for several high-impact, data-driven risk analytics initiatives, including the Aberrational Performance Inquiry of hedge fund returns and the Cherry-Picking Initiatives. SEC Press Release.

Commodity Futures Trading Commission

No-Action Relief

DCO Provides No-Action Relief to Small Bank Holding Companies and Community Development Financial Institutions

On January 8th, the U.S. Commodity Futures Trading Commission’s (“CFTC”) Division of Clearing and Risk (“DCO”) issued no-action relief from the swap clearing requirement to small bank holding companies and savings and loan holding companies having consolidated assets of $10 billion or less, as well as Community Development Financial Institutions that have received a certification from the U.S. Department of the Treasury (“CDFIs”). CFTC Press Release.

Other Developments

CFTC Delegates to NFA Functions Related to Notices of Swap Valuation Disputes

On January 14th, the CFTC issued an order delegating to the National Futures Association (“NFA”) certain responsibilities related to notices of swap valuation disputes filed by swap dealers and major swap participants pursuant to CFTC regulation 23.502(c). CFTC Press Release.

Federal Rules Effective Dates

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Exchanges and Self-Regulatory Organizations

Depository Trust Company

SEC Approves Changes to DTC’s Settlement Service Practices

On January 13th, the SEC issued an order approving The Depository Trust Company’s (“DTC”) proposal to amend its Settlement Service Guide to provide that any Settling Bank that fails to acknowledge its end-of-day net-net settlement balance or fails to notify DTC that it has refused to settle on behalf of a Participant for which it is the designated Settling Bank will be deemed to have acknowledged its end-of-day net-net settlement. SEC Release No. 34-76887.

Financial Industry Regulatory Authority

SEC Institutes Disapproval Proceedings Regarding FINRA’s Proposed Margin Requirements for Covered Agency Transactions

On January 14th, the SEC instituted proceedings to determine whether to approve or disapprove the Financial Industry Regulatory Authority’s (“FINRA”) proposal to amend its rules to establish margin requirements for covered agency transactions, including adjustable rate mortgage transactions, Specified Pool Transactions, and transactions in Collateralized Mortgage Obligations, that are issued in conformity with an agency or Government-Sponsored Entity program with forward settlement dates. Comments should be submitted within 21 days of publication in the Federal Register. Rebuttals should be submitted within 45 days. SEC Release No. 34-76908.

FINRA’s Revisions to Series 9/10 Examination Program Will Appear in March

FINRA announced that it has revised the content of the General Securities Sales Supervisor (Series 9/10) examination program in a regulatory notice published on January 11th. FINRA has divided the content outline into two parts with the eight major job functions, adjusted the number of questions assigned to each job function, and included specific tasks describing activities associated with each job function. The changes will apply to examinations administered on or after March 7, 2016. FINRA Regulatory Notice 16-02.

International Swaps and Derivatives Association

ISDA Announces Changes to Board Composition and Strategy Statement

On January 12th, the International Swaps and Derivatives Association (“ISDA”) announced that it has expanded the size of its board and revised its mission and strategy statement. The new board will increase from 26 to 30 members in an effort to broaden the perspective of the board by including representatives from diverse sectors of the market. The revisions to the ISDA’s mission statement reflect changes to market dynamics and members’ primary concerns, with more emphasis on the importance of an appropriate margin and capital regime. ISDA Press Release.

ISDA Introduces Changes to DC Rules

On January 11th, the ISDA announced that its Credit Derivatives Determinations Committees (“DCs”) approved changes to DC rules that would require DC member firms to establish written policies and procedures concerning the identity of DC decision-makers, identification and management of potential conflicts of interest, and record keeping. Among other things, the changes would set limits on the individuals who can act on a DC firm’s behalf, require firms to make explicit how they should handle any material non-public information obtained through the DC process, and require firms to describe their internal process of deciding how to vote. The rule changes will be implemented beginning in mid-February 2016. ISDA Press Release.

Municipal Securities Rulemaking Board

MSRB Publishes Report Highlighting 2015 Regulatory and Financial Achievements

The Municipal Securities Rulemaking Board (“MSRB”) released its 2015 Annual Report on January 11th, which emphasizes its work on market structure enhancement initiatives, its efforts to improve issuer disclosure practices, its progress in implementing new regulatory standards, and its financial highlights for the fiscal year that ended on September 30, 2015. The MSRB also released audited financial statements alongside the report.MSRB Press Release.  

National Futures Association

NFA Annual Meeting

On January 15th, the National Futures Association (“NFA”) announced that it will hold its annual meeting of NFA Members on February 18, 2016. NFA Press Release.

NFA Offers Guidance to Members Regarding Affirmation Requirements for Exempt CPOs and CTAs.

On January 14th, the NFA issued a Notice to its members regarding the obligation of commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”) to comply with CFTC requirements that they file an affirmation of their exemption from CTA registration by February 29, 2016. The Notice explains that members that take reasonable steps to determine the registration and membership status of previously exempt persons will not be in violation of NFA by-laws if they transact customer business between January 1 and March 31, 2016, with a previously exempt person who fails to comply with the affirmation requirement or to register with the NFA. NFA Notice I-16-03.

NFA Implements Enhancements to CPO Form PQR.

On January 13th, the NFA announced that it has revised CPO Form PQR and made updated schema available in the XML Documentation section of EasyFile for CPO PQR XML filers. NFA Notice I-16-02.

New York Stock Exchange

SEC Approves NYSE Arca’s Proposed Pillar Auction Equity Trading Rules

On January 11th, the SEC approved NYSE Arca, Inc.’s (“NYSE Arca”) proposed rule change to adopt new equity trading rules relating to auctions for its new trading technology platform, Pillar. SEC Release No. 34-76869.

Industry News

Ron Perelman Seeking Out ‘Strategic Alternatives’ for Revlon

DealBook reported that billionaire businessman Ronald O. Perelman is planning to explore “strategic alternatives” for Revlon, the cosmetics company that he has controlled through his investment firm, MacAndrews & Forbes, for over two decades. In its January 15th filing with the SEC, MacAndrews & Forbes stated that it expected “from time to time to communicate with third parties” and Revlon about a possible transaction, but that it had “not formulated any specific or definitive plan.” Revlon.

Chief Compliance Officers Get Ready for Stricter SEC Scrutiny

Chief compliance officers (“CCOs”) are preparing for the SEC’s new requirements that investment funds and advisers make significant improvements in their risk management practices. On January 11th, Pensions & Investments reported on the fact that CCOs at money management firms are feeling vulnerable and are bracing for further SEC scrutiny and possible enforcement actions in 2016. In addition, compliance experts noted that institutional investors should be paying closer attention and being more careful with their own due diligence.SEC Scrutiny.