Category: Restricted

Basel Committee Reform Capital Rules of Derivatives Trading

On June 28th, The Basel Committee came out with two papers that recommend strengthening the regulatory oversight of counterparty credit swaps to decrease the alleged risk of derivative transactions.

The first paper improves upon the interim credit assessment suggestions that the Basel Committee made with the Current Exposure Method (CEM) and the Standardised Method. The new credit risk assessment of counterparties in derivative trading fine-tune upon the CEM and the Standardised Method by creating separate risk exposure plans for margined and unmargined trades.

The second paper focuses on the capital risk of banks when working with central counterparties (CCPs). As is, CCPs are utilized to create stability in the markets by clearing and settling trades through risk and obligation assessment as well as supervising the final swap. The new proposal from the Basel Committee includes a recommendation that all trades are sufficiently well capitalized, as well as suggestions to conserve positive incentives for banks to utilize central clearinghouses.

The Basel Committee was established in 1974 by a group of nations concerned about regulatory inconsistencies between countries. Many of the regulatory policies that it wanted to recommend since the financial crisis of 2008 were supposed to be finalized in 2o12, but have been delayed due to complications.

The two papers published are currently open for public comment until the end of September, 2013.


CFTC Brings Charges Against Corzine For MF Global Collapse

Jon Corzine, the ex-CEO of MF Global, a major derivative broker that went bankrupt in October, 2011, is reportedly being brought up on charges by the CFTC relating to the collapse.

On Thursday, June 27th, the CFTC issued a press release stating that they would be bringing charges against Jon Corzine, the former CEO, and Edith O’Brien, Former Assistant Treasurer, in relation to the derivative giant’s collapse in fall 2011. The collapse took with it over one billion dollars of customer money, and the resolution of the crisis are considered to be one of the largest bankruptcies in the United States. In accounts of the crisis, it seems that MF Global may have unlawfully used customer funds to cover losses.

Corzine originally joined MF Global with intent to turn the futures broker into an investment bank, and according to the CFTC release, “Corzine’s strategy called for making increasingly risky and larger investments of the firm’s money.” Corzine had allegedly been made aware of the low cash balance of the firm, but still continued to order the payback of loans and obligations.

Edith O’Brien, who was an Assistant Treasurer at MF Global is being charged with aiding and abetting, as she allegedly approved and caused the implementation of loans that caused millions of dollars of damage.

Both Corzine and O’Brien plan to fight the charges, but the CFTC hopes to ban them from the futures industry.

No-Action Relief for SDs and MSPs Reporting Regulations Extended

The no-action relief issued to Swap Dealers (SDs) and Major Swap Participants (MSPs), originally set to expire on June 30th, has been extended a year. The relief is regarding reporting regulations that were originally put into place on December 17th, 2012. 

The Division of Market Oversight (DMO) Acting Chair Richard Shilts published a letter on June 26th, 2013 regarding the no-action time-limited relief they originally issued on December 17th, 2012. In the letter, they recommend no-action against any Swap Dealer or Major Swap Participant for failure in complying with regulation 45.4(b)(2)(ii). The regulation and subsequent relief specifically applies to companies failing to comply with the obligatory report of valuation data.

The relief applies to SDs and MSPs that must report counterparties under the regulation, and all cleared swaps that have required counterparty reporting by the SDs and MSPs.

The reasoning behind the extension on this relief dates back to a December 13th, 2012 letter from the International Swaps and Derivatives Association, Inc., (ISDA), which was the original request for no-action relief on this matter. One of the specific concerns cited in the June 26th letter is the connectivity required for valuation data to be reported to all Swap Data Repositories (SDRs).

The new deadline for compliance with this regulation is June 30th, 2014.

CFTC Announcement Could Trigger Lawsuit Over Future of Swaps Data

The U.S. Commodity Futures Trading Commission (CFTC) is set to decide on a rule that could embroil swaps regulation in a lawsuit between CME and DTCC. The rule was delayed last week when the CFTC chose to extend the public comment period on an amendment proposed by CME. The amended rule states:

“For all swaps cleared by the Clearing House, and resulting positions, the Clearing House shall report creation and continuation data to CME’s swap data repository for purposes of complying with applicable CFTC rules governing the regulatory reporting of swaps. Upon the request of a counterparty to a swap cleared at the Clearing House, the Clearing House shall provide the same creation and continuation data to a swap data repository selected by the counterparty as the Clearing House provided to CME’s swap data repository under the preceding sentence.”


CME Group is the country’s largest futures exchange and the operator of the Chicago Mercantile Exchange, the Chicago Board of Trade, and the New York Mercantile Exchange. In October, CME brought a case against the CFTC that challenged the regulatory agency’s ability to enforce reporting rules for swaps trading.  More specifically, CME does not want to be forced to release previously non-public reports on cleared swap transactions to CFTC-mandated swap data repositories (SDRs).

Enter DTCC

This is where DTCC comes into the picture. Although the CFTC eventually granted CME’s request to become an SDR, it had already approved DTCC’s request. If SDRs are challenged in a fundamental way—by allowing CME to function simultaneously as an SDR and a clearinghouse—DTCC stands to lose business.

“DTCC has significant concerns with the potential negative consequences of a judicial challenge or Commission action to remove the necessity for a legal dispute,” DTCC said in a letter to CFTC Chairman Gary Gensler.

Yet CME would prefer to avoid distributing information to a third party. The case, should it develop, will likely hinge on whether the added cost of implementing a third party is necessary and helpful in terms of transparency. CME already functions as a clearinghouse, and so it believes that employing a third party is unnecessary.

Read more.

EMIR, ESMA, CCPs: European Regulatory Calendar for Winter, Spring 2013

Although some key rules have yet to be finalized, the U.S. regulatory regime has, for the most part, entered into an implementation phase. On the other hand, European regulators are determined to establish a single rulebook that would streamline regulatory policy across the member states. While U.S. regulators deal with cross-border issues–with the CFTC being the victim of its own speed–European regulators are finalizing rules on swaps and attempting to come to terms with benchmark rate policy in the wake of Libor.

Below is a calendar for European regulation for the Winter and Spring.

January: EMIR and ESMA

  • New Swaps rules stemming from EMIR have been delayed for one month, until February 19. Apparently, Parliament did not have time to scrutinize the new rules, so they’ve extended the compliance finalization date by one month.
  • It is likely that CRD IV, an initiative that would stimulate bank capital and liquidity, is almost ready. Though the rules may be finalized in January, it is unlikely that they will be implemented quickly.
  • The period of ESMA consultation for interoperability guidelines relating to Central Counterparty (CCP) clearing comes to a close at the end of the month.

February: FSA

  • The FSA will finalize fund management and depository regimes early in the month. There will be more consultations, however, with a policy statement coming sometime in the summer. Additionally, look for FSA’s proposal regarding benchmark rates. This will be an early indicator of where global regulation may head on these rates.
  • Importantly, European regulators will likely agree upon the domain of EMIR and therefore trade reporting and clearing rules for OTC derivatives, including which derivatives will be covered by the rules. Look for an implementation phase later in the Spring.

March: ECB

  • Look for the European Central Bank to make a giant leap toward establishing a single rulebook. Although, as Financial News reports, implementation is unlikely until 2014.
  • Unless it is postponed, we will also a decision by the European Commission on resolution practices for central counterparties (CCP).


Read more.

CFTC, SEC Face Data-Deficit in Coming High-Frequency Trading Fight

The U.S. Commodity Futures Trading Commission (CFTC) and the U.S. Securities and Exchange Commission (SEC) now have FINRA, the financial industry’s self-regulator body, helping to crack down on high-frequency trading (HFT). Yet, barring unforeseen technological changes or a reallocation of resources, it remains to be seen whether 2013 will become the year of HFT regulation.

SEC and Real-Time: Does it Matter for HFT?

Reportedly, the SEC will begin streaming real-time trade data into its headquarters this month.

The SEC’s new technology will reportedly cost $2.5 million in the first year. The adoption of new technology comes on the heels of an announcement by ASIC, the Australian Securities Investment Commission, that it will use high-frequency trading technologies in order to monitor HFTs.

Although the technology itself may help the SEC cover a lingering resources gap, it remains to be seen how the data will be used to monitor trading entities. There is also some speculation as to whether the SEC is currently staffed with analysts who can process the data.

Bad Data or No Data: Enter Kirilenko of CFTC

As it stands, arguments for unregulated HFT stand on a mountain of dubious or unverified analysis. Defenders of HFT routinely cite studies whose authors can be traced back to HFT funding; for example, James Angel, professor at Georgetown, later admitted that HFT data is a “big jumble” even though he published a report in favor of HFT for Knight Capital. This, of course, was prior to the flash crash earlier this year. Or there’s the case of Christopher Culp, hired by Virtu Financial LLC, who wrote a study against transaction taxes, the Wall Street Journal reports.

On the other hand, aside from a landmark study from CFTC economist Andrei Kirilenko, U.S. regulators have put together scant data on the vices of HFT.

The virtue of real-time data (in the hands of U.S. regulators) could be to clarify once and for all the positive or deleterious effects of HFT.

FINRA Comes Out Swinging

Today, FINRA announced their plan to crackdown on HFT and dark pools. TheWall Street Journal reports:

Finra on Tuesday said it implemented a system in 2012 that can track trading patterns that “address more than 50 threat scenarios” across about 80% of the stock market.

Read more.

SEC Forms ‘Formidable Team” With Former CFTC Enforcement Chief

The U.S. Securities and Exchange Commission (SEC) has named Geoffrey Aronow as its top attorney. Aronow formerly served as chief of enforcement at the CFTC from 1995 to 1999, and at the Financial Industry Regulatory Authority (FIRA).

This is new SEC chairman Elisse Walter’s first appointment from outside the agency. According to Bloomberg, Walter and Aronow have known each other for more than twenty years.

“He has a good relationship with the chairman, which is a really important part of that job. I think the two of them will be a formidable team,” said Daniel Waldman, who worked alongside Aronow at the CFTC.

Aronow’s Role at SEC

The chief attorney at the SEC is primarily responsible for evaluating regulation and representing the SEC in lawsuits. To this end, Walter’s appointment seems designed to send signals of continuity and stability within the agency.

“Geoff brings the ideal combination of practical knowledge, expertise, and common sense that is so critical to addressing the often nuanced and difficult issues that come before the Commission,” Walter said in a statement.

Aronow’s appointment may have the added value of cross-pollinating approaches between the agencies, both of which have been criticized in the last year for failing to understand the decision-making processes undertaken by the other, especially in the case of MF Global.

The SEC is also in desperate need of a morale boost after a lackluster 2012 in which it fell significantly behind the CFTC in terms of finalizing rules stemming from Dodd-Frank. According to Michael Greenberger, a professor at the University of Maryland, boosting morale is one of Aronow’s best skills:

“He did a terrific job of leading the enforcement division, improving morale in the division. I think he will be very balanced, but I think he is very open-minded to regulatory reform,” Greenberg said.

Read more about Aronow’s appointment here.

The Basel Debate: Regulators Allow Increased Risk to Maintain Growth

The Basel Committee announced on Sunday that it plans to defang a rule that requires banks to maintain easy-to-sell assets. They committee also extended the compliance date to 2015, at which time banks will only be required to meet 60% of the required liquidity.

The liquidity coverage ratio (LCR) has been the persistent target of the banking lobby for months. The watered down requirements, which allow banks to count a wider array of riskier assets toward a required liquidity buffer, demonstrate a major victory for the banking lobby.

“The rule in its original shape,” reports the WSJ, “would have forced banks to hold enough liquid assets to cover all their expected outflows over a 30-day period in 2015. That deadline is now put back to Jan. 1, 2019, and banks will only have to show a ratio of 60% in 2015. Importantly, banks will now be able to use certain equities, corporate debt and residential-mortgage-backed securities to cover up to 15% of their LCR.”

Although the new rule will phase in over a four year period, Basel Committee members are celebrating the announcement as a high-water mark for the prevailing regulatory regime:

“For the first time in regulatory history, we have a truly global minimum standard for bank liquidity,” said Basel oversight committee chairman Mervyn King.

Basel Decision and the Economy

Although some, like the WSJ, are hailing the decision as a boon to a slow-moving economy, others, like Brooke Masters of the Financial Times, note the considerable ironies of the Basel Committee decision:

“The draft rule, for example, said banks could hold only sovereign debt, top-quality corporate bonds and cash in their liquidity buffers because those were the only truly safe assets. The eurozone crisis undermined part of that argument. Persistent warnings from bankers and traders that there simply weren’t enough ‘safe’ assets to go around did the rest.”

In other words, a hypothetical liquidity crisis is being used to excuse banks from complying with the originally sought after LCR requirement. Riskier assets are now being allowed because otherwise sufficient liquidity may not exist.

“Persistent warnings from bankers and traders that there simply weren’t enough ‘safe’ assets to go around did the rest,” said the Financial Times.

Read more.

Dodd-Frank, Volcker Rule Speculation Reaches Fever Pitch in 2013

The fate of Dodd-Frank and the much debated Volcker Rule are being reconsidered amidst further “fiscal cliff” talks and the arrival of a new Congress.

Dodd-Frank Modified?

The angle taken by The Washington Post suggests that Dodd-Frank could be modified in 2013. This argument suggests that modification could be a bipartisan process: “Rhetoric has softened and bipartisan alliances have formed, leading some analysts to anticipate that meaningful legislation will be on the agenda next year,” said Danielle Douglas of the Post.

Douglas taps into the possibility of bipartisan support for a bill that would rein in big banks:

The bill, sponsored by Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.), asks the agency to study whether institutions with more than $500 billion in assets enjoy favorable pricing of their debt because of inflated credit ratings built on the perception that the government will always step in to prevent their collapse. It’s unclear whether the House will take up the bill before the end of the session, but advocates of reform are encouraged by the broad support in the Senate.

Brown and Vitter are part of a small but growing group of Democrats and Republicans interested in exploring whether the nation’s largest banks need to be downsized to protect financial stability. Analysts say the addition of Sen. Elizabeth Warren (D-Mass.), the architect of the Consumer Financial Protection Bureau, to the Senate Banking Committee will strengthen the coalition.

Fate of Volcker Rule

Meanwhile, speculation on the fate of the Volcker Rule grows daily. A new Financial Times editorial suggests that the Volcker Rule will be finalized this year, although implementation could be blocked until 2015:

In October 2011 regulators released a complex and controversial 298-page proposal to implement the statutory “Volcker Rule” restrictions on proprietary trading and relationships with hedge funds and private equity funds. There has been very little public movement since, even though the statutory Volcker Rule came into effect last July. However, behind the scenes, regulator discourse has been active and fruitful. We expect the result to be a final Volcker Rule in the first half of the year, largely consistent but with the potential for different treatment of different types of entities.

Congress included in the statutory Volcker Rule a “conformance period” for institutions to come into compliance with it. This conformance period, originally expected to be at least two years, ends in July 2014. Given the delay in final regulations, we predict that the Federal Reserve will push the end of the conformance period until at least July 2015.

Simon Johnson, however, writing from the New York Times, undercuts any sense of bipartisan agreement by noting recent attempts to reverse or repeal the Volcker Rule. Johnson cites a letter from the U.S. Chamber of Commerce to the U.S. Trade Representative:

The Volcker Rule is discriminatory, as foreign sovereign debt is subject to the regulation, while Unted States Treasury debt instruments are exempt. This creates a discord in G20 and invites foreign governments to retaliate at a time when we need those same regulators in foreign countries to support initiatives to liberalize trade in financial services. Further, U.S.T.R. should conduct a very close examination to ensure the Volcker Rule does not violate any of our trade obligations.

Read more.


CFTC Penalizes Mizuho in Year’s First Cross-Border Violation

The U.S. Commodity Futures Trading Commission (CFTC) today filed and settled charges against Mizuho Securities of New York for regulatory violations. Among these: Mizuho apparently failed to notify the CFTC of secured fund deficiencies and to “diligently supervise its employees.” As a result of the violations, the CFTC has ordered Mizuho Securities to pay a $175,000 civil monetary penalty and orders Mizuho to cease and desist from violating CFTC regulations.

From the CFTC statement:

The Commodity Exchange Act and CFTC regulations contain provisions to protect the funds of customers trading on both U.S. and foreign exchanges. In relation to customers trading on foreign exchanges, an FCM must account for and maintain money, securities, and property (collectively “funds”) in an amount at least sufficient to cover or satisfy all of its current obligations to foreign futures and options customers in a separate “secured account.”

The CFTC reports that Mizuho was required to hold $536,875,879 in secured funds as of October 7, 2011. It fell somewhat short of this mark. It appears, however, that Mizuho had enough an “excess of segregated funds,” according to a statement issued by the CFTC.

According to the CFTC statement, Mizuho Securities rectified the problem on the day it occurred.

Mizuho became aware of its deficiency in secured funds on Tuesday, October 11, 2011, and cured it that same day. However, Mizuho failed to provide notice of the deficiencies on October 7 and 10 to the CFTC until Wednesday, October 12, 2011.

The CFTC order further finds that Mizuho failed to diligently supervise its employees by failing to provide adequate employee training regarding their obligations to comply with regulation 1.12(h), and because Mizuho did not have policies or procedures in place mandating immediate notification to both the CFTC and its DSRO of any segregated or secured fund deficiency.

Check out more recent enforcement actions from the CFTC.