London Metal Exchange-approved warehouses and other foreign matters took the spotlight this past week in developments related to the financial services industry, including a surprise disclosure regarding a contentious international issue by the new Commodity Futures Trading Commission chairman. In addition, the International Swaps and Derivatives Association announced the agreement of 18 systemically important global banks to delay by one day their right to take certain adverse actions against one another in connection with OTC transactions when their swap counterparty is in imminent collapse and their fate is being resolved by a national regulator. And has anyone seen some missing Securities and Exchange Commission laptops?
As a result, the following matters are covered in this week’s Bridging the Week:
The UK Court of Appeals held that the London Metal Exchange may proceed with a previously announced plan aimed at shortening the amount of time it takes to retrieve metal from exchange-approved warehouses. In doing so, the court set aside a lower court ruling on the matter.
During 2013, the LME was criticized for delivery delays from LME-approved warehouses that some claimed were artificially increasing the prices of certain LME-traded metals worldwide. (Click here for background on this matter in the article “FCA Issues Statement Regarding LME Warehouse” in the November 4 to 8 and 11, 2013 edition of Bridging the Week.)
In response, on November 7, 2013, the LME—after public consultation—proposed a rule that would link the amount of LME-traded metal an exchange-approved warehouse could accept for storage to the amount of the same metal it released whenever the warehouse could not process requests to discharge the same metal from storage in less than 50 days. (This proposal is known as the “LILO” rule, meaning the amount of metal loaded out of a warehouse is linked to the amount loaded in.)
United Company Rusal PLC, an aluminum producer, challenged the consultation process. The company claimed that the LME’s proposed rule would financially hurt producers like itself, and that the LME never adequately considered this potential harm, as it was required to do.
Rusal claimed that other alternatives, such as limiting the storage charges that warehouses could assess on stored metals beyond a certain number of days (a so-called “rent-ban option”), would also reduce the price of relevant metals (such as aluminum) without harming producers. The lower court sided with Rusal. (Click here for a summary of this legal decision in the article “UK High Court Sets Aside LME Proposed Rule Aimed to Reduce Waiting Time at Approved Warehouses to Withdraw Metals in Order to Reduce Aluminum Prices to Commercial Clients and Consumers” in the March 24 to 28 and 31, 2014 edition of Bridging the Week.)
Rusal also had argued that LME’s decision-making was biased “…since it is financed by a stock levy made by it on warehouse charges and thus had an interest in maintaining the amount of the rent charged by warehouse operators.”
In holding for the LME, the appellate court rejected Rusal’s claims and concluded that the exchange’s consultation process regarding the LILO rule was adequate. Although Rusal argued that the LME’s consideration of the rent-ban option during the exchange’s consultation was insufficient, the appellate court noted that Rusal had never advocated for this option before its lawsuit.
In response to the appellate court’s decision, LME announced it would proceed with a two-week consultation and expected to implement the LILO rule on February 1, 2015.
LME acknowledges that market conditions have changed since 2013, and that there is now a greater demand for metals, especially aluminum. However, the LME believes implementation of the LILO rule is still warranted:
[T]he LME also understands that an element of primary production continues to flow into storage—and, in the absence of regulation by the LME, it is to be expected that a significant element of such production would have continued to be loaded into [LME-approved warehouses]. …In particular, the LME believes that the behavioural change exhibited by [LME-approved warehouses] since 1 July 2013 would not have come about had those warehouses not anticipated the introduction of some form of rule-making by the LME.
CFTC Chairman Suggests December 15 QCCP Drama Is Postponed at GMAC Meeting; Committee Reviews NDFs and Bitcoins
The Commodity Futures Trading Commission hosted a meeting of its Global Markets Advisory Committee last week, chaired by Commissioner Mark Wetjen. The principal topics included when the Commission should begin mandating the clearing of foreign exchange-based nondeliverable forward contracts and unique regulatory issues presented by exchange-traded derivative contracts on Bitcoins.
Most surprising was an unrelated announcement by Chairman Timothy Massad during his opening remarks that European regulators have “decided to postpone the imposition of higher capital charges” on European banks that had been expected as of December 15. This is because of European regulators’ failure, to date, to recognize US-based designated clearinghouses as so-called qualified central counterparties. No other details were given in Mr. Massad’s prepared comments.
In his opening statement, Mr. Wetjen observed that there are conflicting views regarding the timeliness of an NDF clearing mandate. However, whatever the decision regarding the timing of a clearing mandate, Mr. Wetjen urged that “the implementation of any such mandate … be aligned with any comparable mandates overseas.” (Click here to see an article regarding the initiation of consultation by the European Securities and Markets Authority regarding NDF mandatory clearing in Europe, “ESMA Begins Consultation on Standards for FX Nondeliverable Forwards Clearing and Proposes Start Dates for Interest Rate Swaps Clearing,” in the September 23 to October 3 and 6 edition of Bridging the Week.)
Mr. Wetjen also observed that one Bitcoin-based derivatives contract has already been proposed by a swap execution facility (TeraExchange, LLC), and other registered and impending-registered platforms intend to list other Bitcoin-denominated contracts too. The discussion at the GMAC dealt with “regulatory challenges that these novel contracts present” as well as “potential benefits that Bitcoin or Bitcoin-like protocols and technology” might introduce to derivatives marketplaces.
Separately, TeraExchange announced last week that the first Bitcoin derivatives transaction had been executed on its trading platform involving a US dollar/Bitcoin swap. (Click here for details of this transaction. Click here for a related article, “Bitcoin: Current US Regulatory Developments” in a November 26, 2013 Corporate/Financial Services Advisory by Katten Muchin Rosenman LLP.)
The UK Financial Conduct Authority announced sanctions against two former directors of Pritchard Stockbrokers Limited related to the firm’s mishandling of client assets. Pritchard was a UK-based firm designated by the FCA to carry on an investment business that was engaged in stock brokerage and wealth management businesses.
The two former directors were David Gillespie, the company’s former managing director, and David Welsby, the firm’s former finance director.
According to the FCA, Pritchard experienced financial problems since 2009. The FCA claimed that “[t]hese financial problems put pressure on Pritchard’s capital adequacy and client money positions and resulted in Pritchard using client money to meet business expenses.” FCA claimed that from July 1, 2010, through February 8, 2012, except for two days, Pritchard had significant shortfalls in client money. In response, Mr. Gillespie allegedly obtained an undocumented GBP 2 million (US $3.2 million) offshore facility to buttress the firm’s client money position. However, this offshore facility was impermissibly included as an available client money resource by Pritchard and Messrs. Gillespie and Welsby.
Because of concerns regarding Pritchard’s handling of client funds, the FCA began a process on February 10, 2012, to secure the firm’s assets and close out existing transactions. By March 2012, the firm had entered a “special administration”—somewhat analogous to a US bankruptcy proceeding.
To resolve this matter Mr. Gillespie and Mr. Welsby agreed to financial penalties of GBP 10,500 and GBP 14,000 (US $16,876 and US $22,500), respectively—reduced amounts in light of their “verifiable evidence of serious financial hardship”—and to be barred from ever being involved in an FCA-regulated activity. Pritchard would have been subject to a financial penalty of almost GBP 5 million (over US $8 million) said the FCA. However, the FCA determined that, given the financial situation of the firm, any funds should be made available to creditors and “decided not to impose a financial penalty upon it.”
Compliance Weeds. This is the latest in a series of CFTC enforcement actions related to violations of its customer protection rules. The CFTC has indisputably put the industry on notice that, no matter what the cause or duration—even if the error was clearly clerical, it will sanction registrants for infractions. At a minimum, FCMs should augment their checks and balances to detect potential customer protection rules violations and regularly review their processes to help ensure that no prior mistakes have been made.
And even more briefly:
For more information, see:
Basel Committee Issues FAQs of Leverage Ratio Framework:
Canadian-Based FCM Fined US $70,000 for One-Day Customer Funds Handling Mistake:
CFTC Chairman Suggests December 15 QCCP Drama Is Postponed at GMAC Meeting; Committee Reviews NDFs and Bitcoins:
GMAC Meeting Opening Remarks of Commissioner Mark Wetjen:
E*Trade Subsidiaries Fined by SEC for Selling Penny Stocks Through Unregistered Offerings:
See also SEC FAQs on Broker-Dealer Obligations in Connection With Unregistered Transactions:
Former CBOT Floor Broker Fined US $200,000 by CFTC for Trading, Recordkeeping and Supervision Violations:
See also, CFTC v. Futures International LLC and Amadeo Cerrone:
Hedge Fund Manager Sanctioned for Defrauding Investors by Hiding Madoff Losses and Theft:
SEC v. Battoo (Order):
See also CFTC v. Battoo et al:
Inspector General Reports Missing SEC Laptops Potentially Containing Confidential Information:
ISDA Announces Stay Agreement for Banks Too Big to Fail:
See also FSB Statement:
Japan SESC Files Spoofing Action:
NYSE to Resume Market Surveillance, Investigation and Enforcement Functions:
Three Senators Criticize CFTC’s Brian Hunter Settlement:
UK Court Authorizes LME to Proceed With Reform of Physical Warehouse Network:
United Company Rusal v. The London Metal Exchange:
LME Press Release
UK FCA Sanctions Two Former Directors for Brokerage Company’s Customer Protection Rule Violations:
Pritchard Stockbrokers Limited
Unnamed Senior Banker Pleads Guilty in UK to LIBOR Offense:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of October 11, 2014. 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 and/or Gary DeWaal 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.