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From Banking and Finance Law Daily, July 30, 2013

SEC and CFTC chairs testify about risk mitigation efforts

By Jacquelyn Lumb

SEC Chair Mary Jo White and CFTC Chair Gary Gensler testified on July 30, 2013, before the Senate Banking Committee on their efforts to improve financial stability and reduce systemic risk in the financial markets through the implementation of the Dodd-Frank Act. Ranking Member Mike Crapo (R-Idaho) noted that the third anniversary of the Act has just passed and there is still work to be done. He expressed concerns about the lack of harmonization and coordination between the U.S. and international regulators on over-the-counter derivatives regulations and said questions remain about the CFTC’s plans to collaborate with the European Union. In addition, Crapo said the SEC and the CFTC appear to be heading in different directions which may again lead to calls to merge the two agencies.

White testified that the SEC has now proposed or adopted virtually all of the rules related to the new oversight regime for OTC derivatives. She said the SEC recognizes the importance of addressing systemic risks and reviewed the initiatives that have been undertaken to date.

Gensler said the CFTC has benefitted from the SEC’s input on its swaps market rules. Eighty swap dealers are now registered, he said, many of which were at the center of the financial crisis. As for rules governing cross-border transactions, he said it will be a multi-year journey and the CFTC is working to smooth the transition to the new reforms.

Dodd-Frank rulemaking. Committee Chair Tim Johnson (D-SD) asked White about the barriers to concluding the Dodd-Frank rulemaking. She noted that the Volcker rule, in particular, is an extraordinarily complex rulemaking, but also pointed to the quantity of rules required under the Act. There is a lot of complexity, and some of the rules have to be adopted jointly with other regulators, she said.

Crapo asked if the chairs agreed about the need for as much coordination as possible in their rule adoptions relating to the OTC derivatives market. White agreed that coordination is important and said there are some differences because of differences in the markets and market participants that the agencies cover.

Gensler also agreed. He said the CFTC shares all of its drafts with fellow regulators, but his agency focuses on futures and swaps while the SEC focuses on many other areas. There are small but important differences in the laws themselves, he added. In some instances, the CFTC was given directions that did not apply to the SEC.

Money market fund reform. Senator Robert Menendez (D-NJ) expressed concerns about a potential floating net asset value as outlined in the SEC’s money market reform proposal. He also cited the concerns of the U.S. Conference of Mayors, which wrote to the SEC in opposition of the proposal. Menendez noted that even the SEC has said that a floating NAV alone will not resolve all of the concerns raised in the aftermath of the financial crisis. Some have suggested that gating — establishing temporary redemption limits — may be more effective.

White assured Menendez that the SEC will consider the impact of the proposal on the marketplace and on municipalities. When Menendez suggested that the Federal Reserve Board wanted the SEC to adopt the proposal, White said the SEC has the expertise and will decide independently on the appropriate action. She also reported that the staff has been in contact with the Department of the Treasury and the Internal Revenue Service with respect to the tax consequences of the proposal.

CEO pay ratio. Menendez also asked about the status of the SEC’s rulemaking related to the disclosure of the ratio between CEO and other workers’ pay. White said the SEC is focused on that rulemaking and predicted action in the next month or two. She said the recent addition of two new commissioners may affect the timetable.

Regulation A+. Senator Patrick Toomey (R-Pa) expressed frustration with the lack of action on Regulation A+ under the JOBS Act, which he sees as a straightforward change in the law. White said the rulemaking should be completed comparatively faster than some of the other initiatives underway. She said the staff is working to ensure that Regulation A+ is workable since current Regulation A is rarely used. When pressed for a timetable, White said action may be taken this fall.

Market manipulation. Senator Sherrod Brown (D-Ohio) questioned Gensler about reports that banks are warehousing metals such as aluminum, which can affect market prices. He noted that the CFTC has sent out notices to several banks warning them not to destroy email, which suggests that an investigation may be underway, and he asked about the CFTC’s enforcement authority. Gensler assured Brown that the CFTC has clear authority with respect to fraud, manipulation, and other abuses.

Brown asked whether the CFTC should adopt rules for the commodity markets to address trading on the basis of nonpublic information. Gensler said there is a long history of permitting market participants such as farmers and grain operators to hedge against risk based on their nonpublic information. Brown said he was not concerned about the small operators, but the large traders. White advised that she has asked the SEC staff to take a look at this area.

Crowdfunding. Senator Mark Warner (D-Va) focused on crowdfunding under the JOBS Act. He said the use of crowdfunding could be transforming and that a nascent market is waiting to use this rule. Warner said he did not expect that the rule would be perfect as initially adopted, but said the upside outweighs that concern. White agreed that there is a great deal of excitement with respect to the use of crowdfunding and assured Warner that it is on the front burner. When Warner pressed for a timeframe, White said the SEC may take action some time in the fall.

Fiduciary duty. Senator Kay Hagan (D-NC) asked White about the status of the initiative to define fiduciary duty for the broker-dealer and investment adviser industries. White said the staff is working with the Department of Labor to ensure its staff understands the broker-dealer operating model. She added that she has met with senior officials of DOL to discuss the initiative.

Rule deadlines. Senator Elizabeth Warren (D-Mass) noted that the CFTC has been under sustained pressure to delay certain of its rules. Gensler said there is still risk in the financial system and the deadlines help entities come into compliance. The CFTC is working to smooth the transition to the new reforms.

Enforcement. Warren also asked both chairs about their willingness to take large financial institutions to trial. White said that additional resources are essential to the SEC’s enforcement strategy and the 2014 budget request would add trial attorneys to the staff. Gensler said the CFTC has not shied away from litigating, but its resources are tiny compared to the market it oversees.

Senator Jeff Merkley (D-Ore) also questioned Gensler about the CFTC’s regulatory power, citing FERC’s recent proceedings against JP Morgan and the LIBOR rates manipulation. He said that Goldman’s aluminum warehouses and JP Morgan’s significant copper assets appear to pose a conflict of interest and the potential for market manipulation. Gensler noted that the CFTC took action against three banks in connection with the LIBOR rate manipulation. Congress gave the CFTC strong rules for enforcement, he said, but it needs funding to back them.

LegislativeActivity: DoddFrankAct FinancialStability SecuritiesDerivatives

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