At the end of each of the last several years, we have shared with readers our list of anticipated areas of focus for the coming year. This particular December, that seems like a harder task than in prior years. With a new administration, which is committed to revisiting regulation, the only thing we can predict with any certainty is that the coming year will bring change.
The new administration will have to make significant appointments that will affect the principal regulatory agencies affecting our markets. Mr. Trump will have the ability to nominate three Commissioners to the Securities and Exchange Commission to work with Commissioner Piwowar, a Republican, and Commissioner Stein, a Democrat. Commissioner Piwowar is expected to be named Chair on an interim basis following current Chair White's announced departure. Of the three new Commissioners, at least one will be a Democrat. Mr. Trump also will be required to appoint new Commissioners to the Commodity Futures Trading Commission. There are only three Commissioners, Chairman Massad, a Democrat, Commissioner Bowen, also a Democrat, and Commissioner Giancarlo, a Republican. Chairman Massad is expected to tender his resignation prior to the end of President Obama's term. This means that Mr. Trump will be able to appoint two new Republican Commissioners and one Democrat. Of course, Mr. Trump also will have the ability to fill vacancies at the banking agencies, including naming a Vice Chairman of Supervision at the Federal Reserve. Through the Congressional Review Act, Congress will have the ability in the near-term to review certain major rules, and it is more likely that change will be effected more gradually since many of the measures that have been discussed by the new administration, including a "roll back" of certain Dodd-Frank Act provisions, would require legislation. Finally, as we discuss further below, a change in tone with respect to enforcement ultimately may be the most significant to market participants.
Below, we highlight a number of the key regulations and initiatives affecting the U.S. market that we will be following closely:
Department of Labor's fiduciary rule: Immediately following the presidential election, market participants were quite focused on the potential for a repeal of the Department of Labor's final fiduciary rule. However, a repeal of the final rule would require the enactment of legislation. The influential Freedom Caucus' report released last week includes a call for the repeal of the final rule. A repeal would take many months and may not be at the top of the legislative agenda for the new administration. The Department of Labor might instead, as we discuss in a prior issue of the newsletter (see: https://media2.mofo.com/documents/161213-structured-thoughts.pdf, page 5), delay the implementation of the rule for some period while rulemaking is considered. With the April 2017 effective date looming and many broker-dealers having already undertaken measures (expected to be rolled out in January 2017) which will allow these entities to transition into full compliance by the effective date, many market participants will not reverse course.
FINRA's proposed rule on senior investors: We anticipate the SEC will approve FINRA's recent proposal (see our post: http://www.bdiaregulator.com/2016/10/finra-proposes-rules-to-protect-seniors-from-financial-exploitation/) which would, among other things, amend existing customer account information rules and adopt a "safe harbor" for brokerdealers to impose a temporary hold on the accounts of senior investors where they suspect financial exploitation of senior investors. The SEC, FINRA, and state regulators have been focused on "at risk" investors, including senior citizens, for some time and the FINRA proposal was generally well received.
FINRA's final rule on mark-ups for debt securities: As we reported in a prior issue of the newsletter (see: https://media2.mofo.com/documents/161213-structured-thoughts.pdf, page 4), in November 2016, the SEC approved FINRA's proposed rules amending Rule 2232. FINRA member firms will be required to provide additional pricing information on customer confirmations for non-municipal fixed income transactions if a FINRA member trades as principal with a non-institutional customer in a corporate debt or agency debt security. Subject to certain exceptions, the member firm would be required to disclose the mark-up or mark-down from the prevailing market price for the security on the customer confirmation. Compliance with the rule is expected to require substantial effort by member firms.
The Federal Reserve Board's final long-term debt, total loss absorbing capacity (TLAC) and clean holding company requirements: As we discussed earlier in this issue, the structured products market already had planned for the final rules with many U.S. G-SIB issuers having established finance subsidiaries through which they will issue debt securities that would not be considered "eligible" long-term debt. The final rules provide additional clarity regarding the types of debt securities that are considered "structured notes." U.S. G-SIBs will generally need to enter into new indentures and make modifications to other regular issuance documents in order to comply with the disclosure and other requirements of the final rules. However, more extensive planning may be required to be undertaken by foreign banking organizations that are G-SIBs and subject to an IHC requirement.
The European Commission's proposed amendments to the BRRD MREL provisions and proposed implementation of the Financial Stability Board's final TLAC principles: As we previously reported (see: https://media2.mofo.com/documents/161209-shaping-mrel-for-european-banks.pdf), the European Commission released proposals in November to amend the Bank Recovery and Resolution Directive in order to provide detailed guidance relating to the MREL requirement applicable to European banks, as well as regulations to implement the TLAC requirement for G-SIBs. Under the FSB principles, structured notes (a term that is not defined) are not TLAC eligible. However, under the EC's proposals, principal-protected structured notes should be eligible to count towards a non-GSIB's MREL and towards any G-SIB's MREL requirements above the MREL floor, in each case to the extent of the principal-protected amount. Foreign bank issuers of structured notes subject to these requirements may undertake a review of their structured note issuance programs in light of these developments. The EC proposals also establish a European IHC requirement for non-European banks that meet certain thresholds, which would include many of the U.S. G-SIBs. As a result, these entities will want to consider their European legal entity structure and funding.
The T+2 settlement initiative: This fall, the SEC, FINRA and the NYSE proposed amendments to various regulations, including, in the case of the SEC, Rule 15c6-1 under the Securities Exchange Act of 1934, in order to shorten the transaction settlement cycle from T+3 to T+2. The shortened settlement cycle is intended to reduce credit risk, market risk, liquidity risk, and overall counterparty risk. Market participants are generally supportive of the move to a shortened settlement cycle; however, the change will impose a substantial burden on broker-dealers. Issuers and underwriters of structured notes will seek to identify ways to further streamline their issuance process to account for the change.
FINRA's cross-selling sweep: In October, FINRA announced a cross-selling sweep in which it requested information regarding the extent to which member firms were promoting bank products of affiliated or parent companies or other services offered by affiliates (such as securities-based lending arrangements) to retail broker-dealer accounts. See our prior summary: https://media2.mofo.com/documents/161116-structured-thoughts.pdf, page 5. Although the sweep was not prompted by any issues arising from structured products, it highlights continued regulatory interest in potential conflicts of interest.
Conflicts of interest: The SEC and FINRA remain focused on the manner in which broker-dealers address potential or actual conflicts of interest. As part of its review of conflicts of interest policies, FINRA held meetings with a number of member firms. It is reasonable to expect that, consistent with past practice, FINRA would share general findings from its review and address the types of conflicts of interest policies and practices that it found to be effective in mitigating risks. Any such findings may ultimately become considered "best practices," to the extent that they are adapted by additional market participants.
Sales to at risk investors: As noted above, FINRA has proposed rule amendments to address senior investors. Sales of complex products and sales of unsuitable products to at risk investors, including senior investors, other investors on fixed incomes or with a need for near-term liquidity or current income, and to affinity groups, likely will remain a focus of attention for the SEC's Office of Compliance Inspections and Examinations, FINRA, and state regulators. Enforcement: The rumored "roll back" of certain Dodd-Frank Act measures may not necessarily involve the repeal of controversial rules, like the Volcker Rule, and may instead translate into a more relaxed enforcement environment, at least in certain areas, for financial institutions. A Culture of Compliance: Despite a possible change in the overall tone taken by regulators toward financial institutions, it is fair to anticipate that, in light of recent events, regulators and also legislators will remain focused on ensuring that regulated institutions promote a culture of compliance. FINRA's 2016 "sweep letter" relating to broker-dealer culture may be followed by similar steps by other regulators.