Bridging the Week by Gary DeWaal

Bridging the Week by Gary DeWaal: March 9 to 13 and 16, 2015 (Skin in the Game; Alleged Spoofing; International Guidance; Another Compliance Officer Sanctioned)

AML and Bribery    Bridging the Week    Chief Compliance Officers    Exchanges and Clearing Houses    My View    Registration    Trade Practices (including Disruptive Trading)   
Published Date: March 15, 2015

The 40th annual FIA Boca Raton International Futures Industry Conference ended last Friday, but many of the topics discussed during the event will resonate for months. These include the profitability of futures commission merchants; capital; clearinghouse risk and what is the appropriate amount of clearinghouse capital that should be made available to the default waterfall; and new initiatives involving back-office outsourcing, Bitcoin and China. Meanwhile, another lawsuit involving spoofing was filed—but this time not by a regulator and not against a specifically named defendant! As a result, the following matters (including my reflections on the Boca conference and the state of the exchange-traded derivatives industry) are covered in this week’s Bridging the Week:

  • CFTC Chairman Suggests European-CFTC Agreement on Clearinghouse Equivalency May Come Soon; Skin in the Game Debate Needs More Study (includes My View);
  • HTG Capital Files Lawsuit to Identify Alleged Spoofer;
  • CFTC Formally Responds to Court Judgment on International Guidance; Calls for Public Comments;
  • FCA Sanctions Compliance Officer for Registrant’s Inadequate Systems and Controls (includes My View);
  • UBS Fined US $500,000 by FINRA for Not Reporting Salespersons’ Tax Liens and Judgments;
  • Five Federal and NYS Regulators Penalize Commerzbank for AML Violations; and more.

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CFTC Chairman Suggests European-CFTC Agreement on Clearinghouse Equivalency May Come Soon; Skin in the Game Debate Needs More Study

In an address before the 40th annual FIA Boca Raton International Futures Industry Conference, Timothy Massad, Chairman of the Commodity Futures Trading Commission, suggested that long-standing issues that have so far resulted in European regulators not recognizing US clearinghouses as subject to equivalent oversight as under European law may be close to resolution.

Without such a determination, European banks utilizing US clearinghouses will potentially be subject to a penalty capital charge beginning June 15, 2015. (Click here for background in the article, “European Banks Receive a Stay From Taking Capital Hits for Exposure to US Clearinghouses,” in the December 8 to 12 and 15, 2014 edition of Bridging the Week.)

In his presentation, Chairman Massad also provided some insight into how the Commission views the debate about the appropriate level of clearinghouse “skin in the game,” without revealing the likely outcome of the CFTC’s deliberations. (Skin in the game refers to the amount of resources a clearinghouse will contribute to the default waterfall from its own capital, as opposed to its members’ resources).

Chairman Massad distinguished between a bank’s need for capital and a clearinghouse’s. Banks, he said, require capital “to offset losses that may arise frequently.” Clearinghouses, however, require capital to cover a very “unusual event” where “there has been a default of a clearing member, and the resources of the of the defaulter held by the clearinghouse—both initial margin and default fund contribution—are not enough to cover the loss.”

The chairman suggested that a determination of an appropriate level of clearinghouse skin in the game should be viewed in the context of what is an appropriate “alignment of incentives between the clearinghouse and its clearing members.” This is particularly relevant, he said, where the equity of clearinghouses is typically now held by outside investors, not members.

Moreover, said the chairman, it is important to consider issues regarding skin in the game in the context of clearinghouse governance. According to Chairman Massad,

whose interests should be taken into account when a clearinghouse designs its recovery plan and when a clearinghouse faces a default? If the waterfall of resources is not sufficient to cover a default, then how does the clearinghouse decide what happens next, and who should participate in or have input into that decision? How do we ensure there is adequate time for that decision-making process to take place?

Although he did not provide insight regarding his thoughts on the possible answers to these questions, the chairman noted that these and other aspects of clearinghouse recovery plans in case of a extraordinary default by a member will be discussed during a roundtable this week at the CFTC.

(Click here for further background on the skin in the game debate, to view the article, “CME Group Adds Its View to ‘Skin in the Game’ Debate” in the January 19 to 23 and 26, 2015 edition of Bridging the Week) and here to view the article, “…While a Clearinghouse—LCH.Clearnet—Weighs in on Clearinghouse Issues Too” in the December 1 to 5 and 8, 2014 edition of Bridging the Week.)

My View: Issues around clearinghouse recovery generally and the appropriate level of skin in the game were among the many important topics addressed during formal sessions and bar-side conversations at the FIA Boca conference. Another major topic often discussed was the decreasing profitability of futures commission merchants because of, among other reasons, increasing capital requirements and regulatory costs. Outsourcing of FCM back-office functions, issues around automated trading, Bitcoin and opportunities involving China were also addressed. Frankly, other than the discussions regarding Bitcoin, most of the conversations were repetitive of those from last year, although the arguments were better refined after a year of rehearsal. Unfortunately, legislators, regulators and industry participants have failed for many years to look at financial services holistically, and instead have endeavored to address discrete issues within silos, with an eye towards the past rather than the future. This is why, to me, legislators and regulators have enacted laws and rules to promote central clearing, on the one hand, but at the same time have enacted capital rules and other regulations that discourage banks (and other brokers) from facilitating central clearing, on the other hand. Futures commission merchants too have bemoaned the low interest rate environment as hurting profitability, forgetting that they are brokers not banks, while at the same time taking too few actions to increase differentiation from their competitors and to enhance customer service. As a result, they are left to compete solely by offering too low rates. The paradigms of yesterday will not work going forward, and unless legislators, regulators and business leaders recognize this, we are likely to be discussing the same topics next year at Boca too—although the break from the Northeast and Midwest winters will always be appreciated!


  • HTG Capital Files Lawsuit to Identify Alleged Spoofer: HTG Capital Partners, LLC, filed a lawsuit in a federal court in Chicago against unnamed defendants, claiming they engaged in spoofing and manipulation of US Treasury futures contracts traded on the Chicago Board of Trade on “thousands of instances" during 2013 and 2014. According to HTG’s complaint, which formally named “John Doe(s)” as defendants, the firm seeks through discovery to identify the precise persons responsible for the alleged wrongful conduct. Once learning these identities, which HTG claims are currently known by the CBoT or Chicago Mercantile Exchange Group, the firm proposes to amend its lawsuit to name precise parties. HTG claims that the defendants’ wrongful conduct comprised three phases: (1) placing orders on one side of the market they intended to cancel before execution for the purpose of inducing other orders by third parties on the same side of the market; (2) cancelling their own orders; and (3) “virtually simultaneously” with their cancellations, placing orders on the opposite side of the market to trade against the orders they initially induced third parties to place (conduct sometimes referred to as “flipping”). In bringing this case, HTG relied on two relatively new provisions of law enacted as part of the adoption of the Dodd-Frank Wall Street Reform and Consumer Protection Act—the prohibition against disruptive trading practices and the prohibition against engaging in any manipulative or deceptive device or contrivance. (Click here for access to the Commodity Futures Trading Commission’s guidance and policy statement regarding the disruptive trading provisions, and here for background regarding the deceptive device or contrivance provisions in the article, “Reflections on the JP Morgan's Settlements—Human Nature, Internal Controls, and the CFTC’s Broad New Anti-Manipulation Authority” in the September 20, 2013 edition of what is now known as Between Bridges.)
  • CFTC Formally Responds to Court Judgment on International Guidance; Calls for Public Comments: In response to the September 2014 decision of a US federal court generally rejecting challenges to the cross-border guidance and interpretation issued by the Commodity Futures Trading Commission in July 2013, the Commission issued an initial response and request for comments last week. The CFTC’s guidance had sought to explain how the agency would apply provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act related to swaps and its recently implemented swaps rules in the cross-border context. Although the federal court mostly upheld the guidance, it ordered the CFTC to conduct a cost-benefit analysis in connection with the extraterritorial application of many of its rules addressed in the guidance. However, the court suggested that this review could be cursory. In response, the CFTC issued its initial response, noting—in a very succinct way—that “it considered costs and benefits on the understanding that the swaps market functions internationally, with many transactions taking place across international boundaries.” However, the CFTC also posed a number of questions, including whether there are any costs or benefits that it applied generally for both domestic and international transactions, “that do not apply, or apply to a different extent, to the relevant rule’s extraterritorial applications.” The Commission is also seeking insight where they are differences in costs and benefits in the domestic and extraterritorial application of a rule, “what are the implications of those differences for the substantive requirements of the rule or rules.” Comments are due by May 11. (Click here for further information on the federal court decision in the article, “Federal Court Tosses Out Challenges to CFTC Cross-Border Guidance and Policy Statement” in the September 16, 2014 edition of Between Bridges. Click here for a different perspective on this regulatory development in the article, "CFTC Responds to District Court's Remand Order on Certain Cross-Border Swaps Rule" in the March 13, 2015 edition of Corporate and Financial Weekly Digest by Katten Muchin Rosenman.) 
  • FCA Sanctions Compliance Officer for Registrant’s Inadequate Systems and Controls: Stephen Bell, the senior compliance officer of two firms that engaged in advisory activity regarding pension investments, mortgages and general insurance/protection products, was sanctioned by the Financial Conduct Authority for the firms’ failure to have adequate compliance systems and controls related to the retention, training and supervision of its registered representatives. Mr. Bell was sanctioned despite FCA acknowledging that “Mr. Bell took significant steps during the [r]elevant period to introduce and improve the firms’ compliance systems and controls.” However, these measures “were ultimately insufficient to ensure that the firms complied with the regulatory requirements,” claimed FCA. The two firms—Financial Limited and Investments Limited—are part of the Standard Financial Group LtdFCA had previously imposed a recruitment ban on the two firms because of their representatives’ alleged mis-selling and provision of unsuitable advice to consumers regarding certain high-risk transactions and other wrongful conduct (click here (regarding Financial Ltd.) and here (regarding Investments Ltd.) for details). FCA claimed that, during the relevant period, August 2008 through April 2013, Mr. Bell was aware of the firms’ failings and need for improvement. Because the systems and controls implemented by Mr. Bell were not adequate to prevent the firms’ regulatory breaches, Mr. Bell was determined by FCA to lack adequate “competence and capability.” In resolving this matter. Mr. Bell agreed to pay a fine of GBP 33,800 (approximately US $50,000) and not to serve as the senior compliance officer for any firm in connection with activity regulated by FCA.

My View: Among international regulators, FCA may be the most aggressive in sanctioning senior compliance officers. However, in prior cases, the compliance officer arguably crossed the line in either affirmatively furthering the bad actions of his/her firm, or misleading FCA (click here for background in the article “FCA Sanctions Bank of Beirut, Former Compliance Officer and Former Internal Auditor for Providing Misleading Information Regarding AML Systems and Controls Remediation” in the March 2 to 6 and 9 edition of Bridging the Week). In this matter, FCA acknowledges that the compliance officer improved the firm’s procedures, but said the improvements were not enough. The sanctioning of a compliance officer regarding the alleged inadequacy of a firm’s procedures absent some affirmative misconduct appears dangerously to transform compliance officers from advisors to a firm, to potential guarantors of the firm’s compliance with all applicable laws and regulations. This is too great a burden and fails to distinguish the difference between an advisor and a supervisor—even accepting that compliance officers have proactive obligations and cannot just give advice and then turn aside and ignore unlawful actions when they know (or reasonably should have known) they are being committed.

  • UBS Fined US $500,000 by FINRA for Not Reporting Salespersons’ Tax Liens and Judgments: UBS Financial Services, Inc. agreed to pay a fine of US $500,000 to the Financial Industry Regulatory Authority related to its alleged failure from about May 2010 to May 2013 to update its individual registrants’ personal information to disclose unsatisfied tax liens and judgments where it had been provided garnishment notices regarding such individuals. This updating was required by FINRA’s rules. According to FINRA, during the relevant time, UBS received wage garnishment orders from courts and tax authorities but did not have a procedure to determine whether the underlying event involved an event that required an update of the relevant individual’s registration information. UBS was previously sanctioned by FINRA for its failure to update individuals’ registration information to disclose reportable customer complaints, regulatory actions or criminal charges from January 2002 through December 2004.
  • Five Federal and NYS Regulators Penalize Commerzbank for AML Violations: Five federal and New York State regulators sanctioned Commerzbank AG for violating various federal and state laws aimed to ensure compliance with US sanctions against specified countries and individuals, and other anti-money laundering requirements. Among other things, the regulators charged that, from at least 2002 to 2007, certain business lines within Commerzbank developed and followed procedures that deleted or caused certain information not to be included that permitted the processing of US dollar-denominated funds transfers through its NY branch or unaffiliated US financial institutions without an assessment of whether the transactions complied with applicable regulations of the Office of Foreign Assets Control of the US Department of Treasury. The bank was also charged with failing to adequately oversee its NY branch to ensure its compliance with applicable AML and Bank Secrecy Act requirements, to provide timely and accurate information to regulators regarding transactions of foreign customers through the NY branch, and with inhibiting efforts of personnel in the NY branch to strengthen transaction monitoring. Among other sanctions, Commerzbank agreed to pay aggregate penalties of US $1.71 billion; to implement a program to ensure its compliance with applicable BSA and AML requirements; and to terminate four employees “who played central roles in the improper conduct.” The five regulators involved in this action are the Board of Governors of the Federal Reserve System, the US Department of Justice, the District Attorney for the County of New York, OFAC and the New York State Department of Financial Services.

And even more briefly:

  • IOSCO Announces Review of Clearinghouse Stress Testing: The Committee on Payments and Markets Infrastructure and the International Organization of Securities Commissions are beginning a review of stress testing by clearinghouses. Under the Principles of Financial Market Infrastructures (click here to access), clearinghouses are required to conduct “rigorous stress testing” to assess the financial resources they require to manage credit and liquidity risk under a wide variety “of extreme but plausible market conditions.”
  • CFTC Announces Next Meeting of Risk Advisory Committee and Reschedules Public Roundtable on Clearinghouse Recovery: The Commodity Futures Trading Commission has rescheduled a public roundtable on the recovery of clearinghouses to March 19. Likewise, the CFTC’s Market Risk Advisory Committee will meet on April 2 to consider risk management measures put in place by derivatives clearing organizations to respond to the default of a significant clearing member as well as market structure. Both meetings will be held at the CFTC’s office in Washington, DC.
  • ESMA Issues Revised Technical Standards Regarding Clearing Obligation for Interest Rate Swaps: The European Securities and Markets Authority has amended its regulatory technical standards to address certain issues raised by the European Commission related to the clearing obligation regarding interest rate swaps. ESMA initially sent its RTS to the Commission for endorsement by October 1, 2014. The Commission notified ESMA it intended to approve the RTS with amendments on January 29, 2015. The matters addressed by ESMA in the amended RTS are non-EU group intra-group transactions and frontloading, among other matters.
  • FCA Provides Guidance On Use of Social Media: The Financial Conduct Authority has provided guidance on how to balance regulatory requirements that require communications by regulated businesses (including financial promotions) to be “clear, fair and not misleading” and space limitations on social media, in an advisory on social media issued last week. The advisory includes visual examples of sample compliant and noncompliant communications on different types of social media.

For more information, see:

CFTC Chairman Suggests European-CFTC Agreement on Clearinghouse Equivalency May Come Soon; Skin in the Game Debate Needs More Study:

CFTC Formally Responds to Court Judgment on International Guidance; Calls for Public Comments:

CFTC Announces Next Meeting of Risk Advisory Committee and Reschedules Public Roundtable on Clearinghouse Recovery:

Clearinghouse Recovery:
Risk Advisory:

ESMA Issues Revised Technical Standards Regarding Clearing Obligation for Interest Rate Swaps:

FCA Provides Guidance On Use of Social Media:

FCA Sanctions Compliance Officer for Registrant’s Inadequate Systems and Controls:

Five Federal and NYS Regulators Penalize Commerzbank for AML Violations (representative actions):

Federal Reserve:
New York State Department of Financial Services:

HTG Capital Files Lawsuit to Identify Alleged Spoofer:

IOSCO Announces Review of Clearinghouse Stress Testing:

UBS Fined US $500,000 by FINRA for Not Reporting Salespersons’ Tax Liens and Judgments:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of March 14, 2015. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.

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