ESMA Contemplates Future Regulation of Blockchains Applications in the Financial Industry

Raised with virtual currencies like Bitcoin, the Distributed Ledger Technology (DLT)—sometimes known as “Blockchains”—is now contemplated for its potential applications in the execution of various types of business transactions and is increasingly stirring the banking and financial industry, which sees DLT both as a potential risk for its traditional activities and as an opportunity to reduce costs and simplify processes. The past months have seen many announcements of large investments in R&D by traditional market stakeholders, as well as newcomers. A smooth race has taken place in order to find and develop operational applications of this technology and to get a competitive advantage or, at least, not to be outrun.

In this context, European governments and authorities are investigating such potential applications and the correlative needs to elaborate an appropriate regulatory framework in order to allow and support the development of DLT while preserving market and investors’ protections ensured by current regulations.

The French government has been a forerunner in this field by stating one of the first legal definitions of a DLT-based trading system: Order no. 2016-520 dated April 28, 2016 on Cash Certificates created the “minibonds” that can be traded through a DLT-based system that complies with certain specifications defined in the Order. French financial and banking authorities have also been very active by setting up dedicated teams to follow fintech outcomes (especially, but not limited to, blockchains) and to collaborate with developers on regulatory issues that may arise.

At the E.U. level, in April 2016, the European Central Bank (ECB) issued an Occasional Paper entitled “Distributed Ledger Technologies in Securities Post-Trading: Revolution or Evolution?” to discuss three potential models of how market players could adopt DLTs for performing core post-trade functions. The European Bank Authority (EBA) set up a Working Group on Cryptotechnology in International Payments and issued, in May 2016, an Information Paper entitled “Applying Cryptotechnologies to Trade Finance,” which contemplated possible applications of DLT for trade finance and how it could improve bank services.

Lastly, at the beginning of this year, the European Securities and Market Authority (ESMA) has made a significant contribution to the reasoning on DLT applications and regulation with the issuance, on February 7, 2017, of a report on “The Distributed Ledger Technology Applied to Securities Markets.” In this report, which comes after an industry consultation process that took place in 2016, the ESMA contemplates possible applications of DLT to the securities market and investigates the needs for specific regulation.

Pragmatically, the ESMA considers that DLT development is too recent to set up general and complete regulation. However, it points out the key challenges—such as standardization and interoperability of various DLT systems, governance, and privacy issues—and risks—such as cyber security, fraud, and systemic risk—that the implementation of the technology in the market will face. Thus, this report gives an interesting overview of what may need to be regulated in the future.

Feature: SEC Sets Sights on Modernizing Disclosure at Open Meeting

On March 1st, the Securities and Exchange Commission (“SEC”) held its first open meeting since the change in presidential administrations and the departure of former Chair Mary Jo White. Under the direction of the two remaining members of the Commission, Acting Chair Michael S. Piwowar and Commissioner Kara M. Stein, the SEC considered a host of non-controversial measures aimed at modernizing disclosure requirements for public companies and other market participants.

The SEC voted to approve final rules that will require issuers to include a hyperlink to each exhibit identified in the exhibit index of certain filings, including Form F-10, Form 20-F, and registration statements and periodic reports subject to the exhibit requirements under Item 601 of Regulation S-K. The rules include exceptions for exhibits that are filed with Form ABS-EE and exhibits filed in the eXtensive Business Reporting language (“XBRL”). The rules will also require registrants to submit these filings in HTML format and discontinue the use of the text-based American Standard Code for Information Interchange (“ASCII”) format, which cannot support functional hyperlinks. Acting Chair Piwowar called the rules “a commonsense improvement that will improve investors’ access to information.” Commissioner Stein noted that the rule “make[s] disclosure more accessible, and create[s] efficiencies for both investors and companies.” The rules will become effective for filings submitted by most filers on or after September 1, 2017, although non-accelerated filers and smaller reporting companies using ASCII format will not have to comply with the final rules until September 1, 2018. The final rules also provide a longer compliance date for certain filings on Form 10-D to permit the SEC to complete programming changes to EDGAR to support the change.

In addition to approving the final rules on the use of exhibit hyperlinks and HTML format in filings, the SEC also proposed amendments to several disclosure rules to require the use of Inline XBRL format for the submission of operating company financial statement information and mutual fund risk/return summaries. The proposed rules would also eliminate the requirement for filers to post XBRL data on their websites. In proposing the rule amendments, the SEC cited several potential benefits, including improved data quality and the eventual reduction of costs of preparing data for submission to the SEC. The proposals include a phased adoption of the requirements based on filer status to mitigate the burden on smaller filers of making the transition to Inline XBRL. The requirements for operating company financial statements would be phased in over a three-year period, while the requirements for mutual funds risk/return summaries would be phased in over a two-year period. Acting Chair Piwowar observed that the proposal “reflects the Commission’s effort to use developments in XBRL technology to lower regulatory burdens and costs.” Commissioner Stein hoped that the proposal would help the SEC and companies make the transition away from a “document-driven, text-based disclosure system [that] is increasingly obsolete.” The SEC has requested public comments on the proposed rule, which should be submitted within 60 days of publication in the Federal Register.

The SEC also voted to propose amendments to Securities Exchange Act Rule 15c2-12, which requires brokers, dealers, and municipal securities dealers that are acting as underwriters in primary offerings of municipal securities to reasonably determine that the issuer or obligated person has agreed to provide timely notice of certain events to the Municipal Securities Rulemaking Board. The proposed amendments would add two new events to the list of event notices included in the Rule, which focus on certain financial obligations incurred by issuers and obligated persons that could impact an issuer’s or obligated person’s liquidity and overall creditworthiness and create risks for existing security holders. The new events would include information regarding the incurrence of a financial obligation of the issuer or obligated person, as well as priority rights, events of defaults, termination events, and modification of terms that reflect financial difficulties. Acting Chair Piwowar commented that the proposal would correct an “information asymmetry among market participants and […] increase transparency to the municipal securities market by improving investor and market participant access to timely information relating to a municipal issuer’s financial obligations.” Commissioner Stein noted that the proposed amendments would “help to put all investors on an equal footing when evaluating the overall financial obligations of issuers.” Comments on the proposal should be submitted within 60 days of publication in the Federal Register.

Finally, the SEC issued a request for comment that invites public input on the effectiveness and possible revision of Industry Guide 3, which provides guidance on the statistical disclosures sought by the Division of Corporation Finance in registration statements and other disclosure documents filed by bank holding companies. The request for comment seeks information regarding the existing disclosure guidance for bank holding companies, both in Guide 3 and other sources of disclosures for these entities and other financial services industry registrants; possible improvements to the disclosure regime, including new disclosures, revisions to existing disclosures, or the elimination of duplicative or overlapping disclosures; the scope and applicability of Guide 3; and the effects of regulation on bank holding companies. Acting Chair Piwowar remarked that Guide 3, which has not been subject to substantive revisions in over 30 years, may no longer reflect a “banking industry [that] has undergone considerable evolution.” Commissioner Stein observed that Guide 3’s “data-centric” approach was “novel” at the time it was adopted, but now should be revisited to see whether its “standards continue to elicit meaningful information for investors.” Comments on Guide 3 should be submitted within 60 days of publication in the Federal Register.

FINRA – Regulatory Matters at a Glance

Please click here to view a summary of the regulatory notices, rule filings, guidance and the like published by the Financial Industry Regulatory Authority (“FINRA”) during the previous month.

Banking Agency Developments


Webinar on FFIEC’s Streamlined Call Report

The OCC announced that on Wednesday, March 8, 2017, from 2pm to 3:30 pm EST, the banking agencies, under the auspices of the Federal Financial Institutions Examination Council (“FFIEC”), will conduct a webinar for bankers to introduce the new FFIEC 051 call report for eligible small institutions, which generally are institutions with domestic offices only and total assets of less than $1 billion. The webinar will cover the content of the call report and discuss how it differs from the existing FFIEC 041 call report. The webinar also will summarize the revisions to the FFIEC 031 and FFIEC 041 call reports. A Q&A period will follow the presentation on the reporting changes for March 2017.

OCC to Host Workshop for Bank Directors in Pittsburgh

The OCC announced that it will be hosting a “Building Blocks for Directors” workshop at the Pittsburgh Marriott City Center in Pittsburgh, Pa., April 10-12, for directors of national community banks and federal savings associations supervised by the OCC. The workshop will focus on directors’ duties and core responsibilities, discuss major laws and regulations, and increase familiarity with the examination process.

OCC to Host Credit Risk and Operational Risk Workshops in Phoenix

The OCC announced that it will be hosting two workshops at the Crowne Plaza Phoenix Airport in Phoenix, Ariz., April 11-12, for directors of national community banks and federal savings associations supervised by the OCC. The Credit Risk workshop on April 11th will focus on credit risk within the loan portfolio, such as identifying trends and recognizing problems. The workshop will also cover the roles of the board and management, how to stay informed of changes in credit risk, and how to effect change. The Operational Risk workshop on April 12th will focus on the key components of operational risk – people, processes and systems. The workshop will also cover governance, third-party risk, vendor management, and cybersecurity.


CFPB Oversight Uncovers and Corrects Credit Reporting Problems

On March 2nd, the Consumer Financial Protection Bureau (“CFPB”) announced its release of a report detailing the problems in the credit reporting industry that the Bureau has uncovered and corrected through its oversight work. This report outlines the actions that the CFPB has taken to address these ongoing problems such as fixing data accuracy at credit reporting companies, repairing the broken dispute process, and cleaning up information being reported.

Securities and Exchange Commission

Exemptive Orders

SROs Obtain Limited Exemption from Website Publication of Certain Data from Tick Size Pilot

On February 28th, the SEC’s Division of Trading and Markets granted a request by several self-regulatory organizations (“SROs”) for a limited exemption from the requirements of the National Market System Plan to Implement a Tick Size Pilot Program to publish on their websites certain data regarding Pilot Securities on a monthly basis. The SROs requested the exemptive relief, which extends the deadline for posting the data until April 28, 2017, due to confidentiality concerns related to the publication of the data.     

Speeches and Statements

Piwowar, Stein Discuss Securities-Based Crowdfunding at SEC-NYU Dialogue Event

SEC Acting Chair Michael S. Piwowar and Commissioner Kara M. Stein each addressed the SEC-NYU Dialogue on Securities Market Regulation: U.S. Securities-Based Crowdfunding on February 28th. Acting Chair Piwowar described Regulation Crowdfunding as “a fundamental alteration of nearly 80 years of U.S. securities law practice” with great potential to facilitate capital formation, but raised concerns that the rules in their current form are “too restrictive and burdensome.” Commissioner Stein discussed the role of funding portals as gatekeepers as well as facilitators of capital formation, concerns regarding the risks of so-called SAFE securities, and concerns about concentration within the crowdfunding marketplace.

Stein Looks to the Present and Future of Financial Markets in Conference Remarks

In remarks at the SEC Speaks conference on February 24th, SEC Commissioner Kara M. Stein examined conditions in today’s financial markets, including “the rise of institutional investors, the move to private markets, and the evolution of electronic trading,” and their potential impact on capital formation and investor protection. Stein also cautioned against “rush[ing] to eliminate disclosure,” advocating instead to leverage technology “to make disclosure better.”      

Other Developments

Investor Advocate to Host Evidence Summit on Investor Understanding and Behavior

The SEC’s Office of the Investor Advocate announced on March 2nd that it will hold a public conference on March 10, 2017, to consider potential strategies for enhancing retail investors’ understanding of key investment characteristics, including fees, risks, returns, and conflicts of interest. The aim of the conference, described as an “Evidence Summit,” is to inform ways of thinking about investor behavior and identify areas for possible future research to be conducted by the Investor Advocate’s office under an investor research initiative known as Policy Oriented Stakeholder and Investor Testing for Innovative and Effective Regulation (“POSITIER”). SEC Commission Notice.

SEC Makes IFRS Taxonomy Available for XBRL Submissions by Foreign Private Issuers

On March 1st, the SEC announced that the IFRS Taxonomy is available on its website for use by for foreign private issuers in submitting their financial statements in XBRL, pursuant to Rule 405 of Regulation S-T. Foreign private issuers that prepare their financial statements in accordance with International Financial Reporting Standards (“IFRS”) may begin to submit their financial statements in XBRL immediately, and all such issuers will be required to do so for fiscal periods ending on or after December 15, 2017. SEC Commission Notice.

DERA White Paper Analyzes Initial Offering Activity in Title III Crowdfunding Market

On February 28th, the SEC published a white paper prepared by staff in its Division of Economic and Risk Analysis (“DERA”) that examines the initial offering activity in the crowdfunding market for offerings made pursuant to Title III of the JOBS Act, which created a new exemption from registration for certain Internet-based securities offerings. The white paper analyzes offering activity during the first six months following the effective date of the final rules.

Federal Rules Effective Dates

March 2017 – May 2017

Click here to view table. 

Exchanges and Self-Regulatory Organizations

BOX Options Exchange

SEC Institutes Disapproval Proceedings for BOX’s Proposed Rules on Open-Outcry Trading

On March 1st, the SEC instituted proceedings to determine whether to approve or disapprove a proposed rule change filed by BOX Options Exchange LLC (“BOX”) to adopt rules for an open-outcry trading floor. The SEC also provided notice of BOX’s amendment to the proposal, which removed proposed rule language relating to BOX’s minor rule violation plan, proposed a disciplinary process for the trading floor, proposed rules for split price transactions, and clarified various aspects of how orders will be handled on the trading floor. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of March 6, 2017. Rebuttals are due within 35 days. SEC Release No. 34-80134.    

Chicago Board Options Exchange

CBOE Proposes Changes to Rules on Unusual Market Conditions

On February 28th, the SEC requested comments on a proposed rule change filed by the Chicago Board Options Exchange Incorporated (“CBOE”) that would amend its rule on unusual market conditions to update the circumstances in which CBOE may declare a “fast” market, add actions CBOE may take when a fast market has been declared, and remove outdated provisions. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of March 6, 2017. SEC Release No. 34-80123.     

Financial Industry Regulatory Authority

FINRA Reveals Rulemaking Items for Consideration at Board’s March Meeting

On March 1st, FINRA announced the rulemaking items that will be considered by its Board of Governors at its March meeting, which will take place on March 8, 2017. Among other matters, the Board will consider rulemaking proposals concerning corporate financing, government securities, Trade Reporting and Compliance Engine (“TRACE”) data products, and the late cancellation of prehearing conferences in arbitration.

FINRA Offers FAQs on TRACE for Treasuries

On February 27th, FINRA announced that it has published frequently asked questions (“FAQs”) to help firms in reporting Treasuries transactions to TRACE, which will be required starting on July 10, 2017.      

International Swaps and Derivatives Association

ISDA Updates Compliance Calendar for OTC Derivatives

On March 1st, the International Swaps and Derivatives Association (“ISDA”) published an updated version of its OTC Derivatives Compliance Calendar.

ISDA Publishes SwapsInfo Fourth Quarter 2016 Review

On February 28th, ISDA published its quarterly review of interest rate derivatives and credit default swap index trading activity for the fourth quarter of 2016. The report analyzes the impact of regulatory change on swap execution facility and bilateral trading volumes, as well as cleared and non-cleared activity.     

Municipal Securities Rulemaking Board

MSRB Proposes to Amend and Clarify Rule on CUSIP Numbers

On March 1st, the Municipal Securities Rulemaking Board (“MSRB”) requested comments on draft amendments to MSRB Rule G-34, which requires brokers, dealers, and municipal securities dealers to obtain CUSIP numbers for a new issue of municipal securities. The draft amendments clarify the application of the rule to private placement transactions and expand it to include non-dealer municipal advisors when advising on new issue municipal securities sold in a competitive offering. Comments should be submitted on or before March 31, 2017. MSRB Press Release.

MSRB Supports SEC’s Proposal to Enhance Bank Loan Disclosure

The MSRB issued a statement on March 1st that responds to the SEC’s proposal to amend Exchange Act Rule 15c2-12 to include two required event disclosures related to bank loans and other alternative financings entered into by issuers of municipal securities. The MSRB expressed support for the SEC’s proposal, noting that it has encouraged voluntary bank loan disclosure by municipal securities issuers through its Electronic Municipal Market Access (“EMMA”) website.     


Nasdaq Proposes New Rule to Provide Additional Information to Stabilizing Agents on Follow-On Offerings

On February 28th, the SEC requested comments on a proposed rule change filed by The NASDAQ Stock Market LLC (“Nasdaq”) that would permit the exchange to adopt a new rule to enhance the level of information provided to a member acting as a Stabilizing Agent for a follow-on offering of additional shares of a security that is listed on Nasdaq. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of March 6, 2017. SEC Release No. 34-80120.     


SEC Approves NYSE Arca’s Amendments to Rules on Electronic Complex Orders

On March 1st, the SEC granted accelerated approval to NYSE Arca, Inc.’s (“NYSE Arca”) proposal, as amended by two amendments filed by NYSE Arca, to clarify and provide greater specificity to its rules governing the trading of Electronic Complex Orders, and to correct inaccuracies in those rules. SEC Release No. 34-80138.

SEC Institutes Proceedings on NYSE MKT’s Proposals on Unlisted Trading Privileges

On February 24th, the SEC instituted proceedings to determine whether to approve or disapprove NYSE MKT LLC’s (“NYSE MKT”) proposed rule change to allow NYSE MKT to trade, pursuant to unlisted trading privileges (“UTP”), any NMS Stock listed on another national securities exchange; establish rules for the trading pursuant to UTP of exchange-traded products; and adopt new equity trading rules relating to trading halts of securities traded pursuant to UTP on NYSE MKT’s Pillar trading platform. Comments should be submitted on or before March 22, 2017. Rebuttals are due on or before April 5, 2017. SEC Release No. 34-80097.

Judicial Developments

Panel Affirms Conviction of Man Who Received Insider Trading Tip on a Country Club Napkin

A jury convicted Bray of insider trading after he got a tip about a bank on a country club napkin from a fellow member/bank executive and then used that nonpublic information to make a trading profit. The First Circuit affirmed on February 24th, finding that the tip’s secretive manner was enough for the jury to decide that Bray knew that his tipper was giving him confidential information. Also, the district court’s error in instructing the jury that it could convict Bray if he “should have known” that the tipper had an obligation to keep the information confidential did not jeopardize the trial’s fairness. United States v. Robert H. Bray.

Industry News

Top U.S. Federal Reserve Official Warns of Digital Currency’s Dangers

Federal Reserve Governor Jerome Powell said at a Yale Law School conference that central banks that issue digital currencies are vulnerable to cyber attacks and criminal activities, along with privacy issues that still need to be addressed. He noted that a digital currency like bitcoin would be a “prime target” for global criminal activities including money laundering, and added that central banks would need to keep track of digital currency issuance but could raise serious privacy concerns by users. Reuters.     

Major U.S. Financial Regulators Discuss Nonbank Firm’s ‘Too Big to Fail’ Designation

Reuters reported that the Financial Stability Oversight Council, which consists of all major U.S. financial regulators, met on March 2nd to review its designation of a nonbank firm as “too big to fail.” This was the first such meeting chaired by newly confirmed Treasury Secretary Steven Mnuchin.     

Shkreli and Lawyer Seek Separate Trials So They Can Blame Each Other

On February 27th, DealBook reported that Martin Shkreli and the lawyer who advised Shkreli’s company, both of whom were charged with conspiracy and securities fraud, have asked a federal district judge to grant them separate trials so that they can blame each other for any violations.