Bridging the Week by Gary DeWaal: March 28 – April 1, and 4, 2016 (Complex Regulation; Accessible Data; EFRPs; Blockchain; ISDAfix)

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Published Date: April 03, 2016

The US Government Accountability Office has again raised issues regarding the complexity and overlap of the US financial regulatory system. Separately, a commissioner of the Commodity Futures Trading Commission called for a “do no harm” approach to regulation in order not to inhibit the evolution of blockchain and distributed ledger technologies. In addition, the European Securities and Markets Authority fined, for the first time, a trade repository for allegedly not having systems to permit regulators immediate and direct access to derivatives trading data. As a result, the following matters are covered in this week’s edition of Bridging the Week:

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GAO Claims US Financial Services Regulation Still Complex and Fragmented

Last week, the US Government Accountability Office reported that US oversight of financial services entities and products has not meaningfully improved since its issuance of a comprehensive study more than seven years ago that warned that the US financial regulatory system “appears to be ill-suited to meet the nation’s needs in the 21st century” because of its high level of complexity and overlap.

In its latest study, GAO said that the US financial regulatory system continues to be “complex, with responsibilities fragmented among multiple agencies that have overlapping authorities.”(Click here to access GAO’s 2009 study.)

GAO noted that the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act introduced a number of reforms to improve coordination among financial regulators. These included the establishment of the Financial Industry Oversight Council and the Office of Financial Research. However, said GAO, “collaborative efforts have not been sufficient, and FSOC’s authorities are limited and unclear.” According to GAO, this has caused “inefficiencies in regulatory processes, inconsistencies in how regulators oversee similar types of institutions, and differences in the levels of protections afforded to consumers.”

GAO identified inconsistencies in the examination of depository institutions by different regulators, the lack of uniformity in insurance regulation and the sometimes duplicative and inconsistent regulation of securities and derivatives market participants by different regulators as prime examples of problematic oversight.

As a specific evidence of its observations, GAO noted that the Commodity Futures Trading Commission and the Securities and Exchange Commission both were given oversight over elements of swaps trading under Dodd-Frank. In response, each agency has endeavored to coordinate with the other to develop applicable regulation, as required under law. However, there have been subtle but important differences in approaches to regulation (e.g., the definition of a US person under CFTC and SEC cross-border provisions), and delays by the SEC in finalizing rules that market participants fear “could lead to operational challenges …, as well as uncertainty and regulatory inefficiencies and burden.”

GAO also observed that the complexity of the US financial regulatory system complicates coordination on some issues with international regulators because there is no unified US view.

In response, GAO posited that Congress “should consider whether additional changes to the financial regulatory structure are needed to reduce or better manage fragmentation and overlap,” including whether a “number of federal agencies” should be consolidated. GAO also suggested that Congress should consider whether “legislative changes are necessary to align FSOC’s authorities with its mission to respond to systemic risk.”

GAO is an independent, non-partisan federal agency that supports Congress in ensuring that US government funds are spent “efficiently and effectively.” In 2010, GAO issued a study identifying overlaps and inefficiencies in the regulation of financial markets by the SEC and CFTC. (Click here to a copy of this study.)

My View: Just like GAO’s recommendations mostly fell on deaf ears during the height of the financial crisis in 2009, its current recommendations are likely to be similarly ignored in the highly partisan environment of Washington, DC, today. This is a shame. The US financial regulatory system is broken and inefficient, and clearly needs fixing. As GAO observed in 2009, “[m]uch of [today’s] structure has developed as the result of statutory and regulatory changes that were often implemented in response to financial crises or significant developments in the financial services sector.” The US financial regulatory system has not benefited from a holistic examination of what makes most sense today, let alone what might make most sense tomorrow. Oversight of financial regulators is also spread among too many congressional committees, and this impedes thoughtfulness and rationalization. But it is critical in order for the United States to be competitive internationally in financial services for such a reflection to occur and oversight to be rationalized. Maybe next year. We can only hope. 

CFTC Commissioner Calls for Regulators to “Do No Harm” in Development of Distributed Ledger Technology; Other Regulators Weigh in Too:

J. Christopher Giancarlo, Commissioner of the Commodity Futures Trading Commission, called for regulators, including the CFTC, to “do no harm” in permitting the new blockchain or distributed ledger technology to develop.

DLT, introduced in connection with transactions involving Bitcoin, references a public ledger of all transactions referencing an item that is automatically updated to include the latest and all prior transactions. A DLT should not be subject to tampering or independent revision.

According to Mr. Giancarlo, the model for a “do no harm” regulatory approach is the path regulators followed during the initial days of the Internet. According to Mr. Giancarlo, back in the 1990’s,

a Republican Congress and the Clinton administration established a set of foundational principles: the Internet was to progress through human social interaction, voluntary contractual relations and free market. Governments and regulators were not to harm the Internet’s continuing evolution.

As a result of this approach, claimed Mr. Giancarlo, the Internet flourished, “created jobs, increased productivity and fostered innovation and consumer choice.” Mr. Giancarlo argued that, by following the same approach now, the DLT can most effectively be permitted to evolve in a similar fashion.

To accomplish this, US and foreign regulators should “coordinate to create a principles-based approach for DLT oversight in order to provide the flexibility, certainty, and harmonization necessary for this technology to flourish.” The CFTC itself, said Mr. Giancarlo, should examine and revise it rules – such as its recordkeeping requirements – to ensure they are technologically neutral to avoid inhibiting DLT development.

In a separate speech before SEC-Rock Center for Corporate Governance’s Silicon Valley Initiative, May Jo White, Chairperson of the Securities and Commission, indicated that her agency is currently considering whether certain blockchain applications may require registration as transfer agents or clearing agencies. She observed that the SEC recently reviewed the registration statement of Overstock, Inc., which is seeking to offer and sell digital securities that trade and settle entirely on the blockchain, bypassing intermediaries.

Relatedly, last week the office of the Comptroller of the Currency issued a paper articulating standards it will apply to support “responsible innovation” in the federal banking system. These principles included supporting “responsible innovation” and fostering “an internal culture receptive to responsible innovation.”

Legal Weeds: The CFTC has previously determined that Bitcoin and other virtual currencies are “commodities” under applicable law. (Click here for details in the article, “CFTC Says Virtual Currencies Are a “Commodity” Under Federal Law, Files Charges Against Coinflip for Operating an Unregistered Bitcoin Options Trading Platform” in the September 20, 2015 edition of Bridging the Week.) This is likely a correct interpretation as under applicable law, commodities are broadly defined as any goods, articles, services, rights and interests “in which contracts for future delivery are presently or in the future dealt in” with two exceptions: onions and motion picture box office receipts, or any “index, measure, value or data related to such receipts.” Moreover, with limited exceptions (most notably, involving securities), the CFTC has exclusive jurisdiction under applicable law with respect to all trading of commodities of the nature of options, futures and swaps, including over most market participants. It is not certain, however, that the New York State Department of Financial Service is prepared to restrict its regulation of virtual currency transactions and intermediaries through imposition of its so-called “BitLicense” and other requirements to the extent such obligations impact activities and persons under the exclusive jurisdiction of the CFTC. It is also not clear how states that adopt their own BitLicense-type provisions will address CFTC exclusive jurisdiction regarding certain aspects of digital currency businesses (click here to access the proposed model state BitLicense equivalent law, the Regulation of Virtual Currencies Act). It will be interesting to watch this space going forward to see whether a jurisdiction fight emerges. (Click here to review the relevant provision of law related to the definition of a commodity and here for the scope of the CFTC’s exclusive jurisdiction. Click here for background on the NYS Department of Financial Services’ “BitLicense” requirements in the article, “NYDFS Issues BitLicense Framework for Regulating Virtual Currency Firms” in the June 7, 2015 edition of Bridging the Week.)


Compliance Weeds: In connection with EFRPs, one party must sell the exchange contract and buy approximately the same quantity of the related position (or the market exposure associated with the related position), while the other party must buy the exchange contract and sell the same approximate quantity of the related position or associated market exposure. The related position must be the cash commodity associated with the exchange contract or a by-product, a related product or an over-the-counter derivative instrument of such commodity that is reasonably correlated to the exchange contract. EFRPs must result in a real transfer of a cash commodity between the parties or a legal binding agreement between the parties governing the related position consistent with prevailing market conventions. (Click here for CME Group guidance regarding EFRPs, here for ICE Futures U.S. guidance, and here for CBOE Futures Exchange guidance.)

Compliance Weeds: The requirement that an investment company’s board members request and evaluate information “as may be reasonably necessary” to appoint an adviser is established by statute (Section 15(c) of the Investment Company Act; click here to access). Thus the failure of board members to follow this requirement, including following up when incomplete information was provided in response to a request for information, may be deemed a violation of law, as the SEC charged in the second matter referenced by Chairperson White. However, not following up on incomplete or facially inaccurate information in response to any internal investigation or review, or due diligence inquiry, could cause later regulatory issues for any regulated firm or person, whether the initial request was mandated by law or not, if something bad happens and later it is thought that review of the missed information might have “reasonably” prevented a regulatory incident. However, the determination of reasonableness will likely only be determined after the fact. Be mindful!

And more briefly:

For more information, see:

CFTC Commissioner Calls for Regulators to “Do No Harm” in Development of Distributed Ledger Technology; Other Regulators Weigh in Too:

See also:
OCC Report:
Press Announcement, Overstock, Inc:
Speech of Mary Jo White:

CME Group Sanctions Eight Companies for Non-Bona Fide EFRPs; IFUS Sanctions an Individual for Disruptive Trading:

CME Group actions:
BOCI Global Commodities:
Cargill International:
HSH Nordbank:
Oak Futures:
Strong Petrochemical:
UNIPEC Singapore:
United Overseas Bank:

IFUS action:
Alan Rabinowitz:

ESMA Fines Trade Repository for Not Having Systems With Data Immediately Accessible by Regulators:

GAO Claims US Financial Services Regulation Still Complex and Fragmented:

ICE Futures Europe Updates Guidance on Position Limits and Accountability Levels:

IFUS Proposes to Expand FCMs’ AML Responsibilities Under Its Rules:

IOSCO Updates Information Repository of Central Clearing Requirements by Jurisdiction:

ISDAfix Class Action Authorized to Proceed by Federal Court:

No Fingerprint Rule for Foreign Natural Persons Finalized by CFTC:

OFAC Blocked Persons and Specially Designated Nationals List Revised:

SEC Chairperson Muses About Mutual Fund Directors’ Responsibilities and Potential Enforcement Interest:

US Supreme Court Declines to Consider SEC Administrative Forum Selection:

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of April 2, 2016. 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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Gary DeWaal

Gary DeWaal is currently Special Counsel with Katten Muchin Rosenman LLP in its New York office focusing on financial services regulatory matters. He provides advisory services and assists with investigations and litigation.

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