Last week, the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions gave good grades to regulators in Europe, Japan and the United States for their implementation of best practices for key financial market infrastructures, including clearinghouses, The same regulatory organizations also recommended a common template for all clearinghouses so that stakeholders could more fairly compare the entities’ risks, risk controls and systemic importance. Separately, a Bank of England report concluded that high frequency traders may be good for the marketplace (at least the equities markets in the United Kingdom). As a result, the following matters are covered in this week’s Bridging the Week:
- Europe and US Receive Good Grades for PFMI Implementation; Japan Receives the Best Grade;
- Bank of England Report Finds Positive Impact on UK Equities Markets by High Frequency Traders (includes My View);
- CME Group Sanctions Firm and Traders for Wash Trades Used to Transfer Positions and Another Firm for a Deficient Algorithm (includes Compliance Weeds);
- Court Rules CFTC Lawsuit Against Multiple Clients' Attorney May Proceed;
- CPMI and IOSCO Propose Uniform Disclosure Standards for CCPs;
- NY-Based Broker-Dealer Sanctioned by FINRA for Not Having Adequate Procedures to Ensure Employee Did Not Trade on Insider Information;
- Asset Managers Warned to Avoid Conflicts by SEC Asset Management Unit Co-Chief…;
- …FCA Fines Investment Manager for Conflicts;
- Canadian Regulators Not High on Medical Marijuana Industry Disclosures (includes Totally Irrelevant (But is It?); and more.
Europe and US Receive Good Grades for PFMI Implementation; Japan Receives the Best Grade
Regulators in the European Union, Japan and the United States have made “good progress” in implementing the Principles of Financial Market Infrastructures, according to a peer review conducted and publicized last week by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions.
CPMI and IOSCO found that, generally, regulators have made greater progress in implementing the Principles related to central clearing counterparties (CCPs), while their efforts to apply the Principles to trade repositories (TRs) “has been more varied.”
The PFMIs—which the Committee on Payment and Settlement Systems and IOSCO adopted in April 2012—are high-level best practices for key financial market infrastructures, including financial exchanges, TRs and CCPs (e.g., clearinghouses and clearing agencies (CCAs)), that set forth standards for organization; credit and liquidity risk management; settlement; default management; general business and risk management; and other topics (click here to access the Principles).
CPMI and IOSCO found that US regulators (the Commodity Futures Trading Commission, the Securities and Exchange Commission and the Board of Governors of the Federal Reserve System) have “developed rules that completely and consistently implement the majority of the Principles that are applicable to CCPs.” However, CPMI and IOSCO found that the CFTC has not sufficiently implemented a principle for systemically important derivative clearing organizations (SIDCOs) that requires potential principal risk caused by exchange of value settlements to be mitigated solely through a delivery-versus-payment mechanism. Instead, the CFTC permits SIDCOs to manage this risk through the use of “appropriate tools and procedures,” which the regulatory organizations claim “is far more general and could conceivably be met by the use of measures other than DvP.”
CPMI and IOSCO also found that the SEC’s proposed regulations regarding CCAs do not include an unambiguous requirement that a CCP use central bank money “where available and practical,” and fail to set forth in sufficient detail requirements related to a board of director’s role in the governance of a CCP’s operational risk management framework (including business continuity requirements).
CPMI and IOSCO likewise found regulations adopted in Europe regarding CCPs (e.g., the European Market Infrastructure Regulation) are “consistent or broadly consistent with a majority of the Principles” but identified a number of specific areas requiring improvement. The regulatory organizations concluded that Japan “has completely and consistently adopted the Principles applicable for CCPs and TRs,” effectively giving it the best grade.
All assessments were as of April 18, 2014. CPMI operates under the umbrella of the Bank for International Settlements.
- Bank of England Report Finds Positive Impact on UK Equities Markets by High Frequency Traders: A Bank of England research report concluded that high frequency traders had a positive impact on UK equity markets, and did not “generally contribute to undue price pressure and price dislocations.” Two of the four authors of the report work for the Bank of England, while the other two authors are academics at the University of Cambridge and the University of Gothenburg. Although the report concluded that HFTs tend to buy and sell multiple and individual stocks more aggressively than comparable investment banks, “trading by HFT firms are associated with a permanent impact whereas … trading by investment banks is associated with only a temporary price impact.” The authors said this is because HFTs are more likely to react to “new information,” which tends to make market prices “more efficient.” Aggressive trading by an HFT tends to prompt more aggressive volume in the same direction of the trading by other HFTs in the next few minutes. Contrariwise, aggressive trading by an investment bank tends to lead to more aggressive trading by other investment banks in the opposite direction. Accordingly, said the authors, “correlated trading among HFTs are associated with a permanent price impact, whereas instances of correlated bank trading are, in fact, associated with future price reversals.”
My View: Contrast this BOE research report with an article by Gregory Scopino, an attorney with the Commodity Futures Trading Commission, entitled, “The (Questionable) Legality of High-Speed ‘Pinging’ and ‘Front Running’ in the Futures Markets,” that appeared earlier in February in the Connecticut Law Review (click here to access the article). Mr. Scopino’s composition suggests that high frequency traders in futures markets sometimes engage in an activity known as “pinging” that permits them to front run other traders. Through this activity, alleges Mr. Scopino, HFTs enter one-lot orders, receive their fill, and use this trade information to place other orders to the detriment of other market participants. Mr. Scopino claims that this type of activity may be illegal under applicable law and CFTC regulations. Although Mr. Scopino’s views likely reflect, at most, a minority view of applicable law, his article provides another example of the ongoing strong emotions engendered by HFT techniques. The BOE research report is a refreshing, dispassionate, quantitative look at the potential positive impact HFTs apparently have on liquidity in at least one market segment—UK equities.
- CME Group Sanctions Firm and Traders for Wash Trades Used to Transfer Positions and Another Firm for a Deficient Algorithm: Cargill de Mexico S.A. de C.V. and two of its employees were fined US $80,000 in aggregate by CME Group for engaging in wash trades on six days between June 2013 and January 2014. CME Group alleged that, on these days, the two employees—Jesus Avila and Jose Gamboa—traded agricultural products involving opposite positions in the same delivery month when they “reasonably should have known” that the orders would trade against each other on Globex. The purpose of these transactions was to transfer positions from one account to another with the same beneficial order, wrote the CME Group in its notices of disciplinary action related to this matter. The respondents settled this matter without admitting or denying any rule violations. The individual respondents also agreed to a five-day CME Group trading prohibition as part of their sanctions, while Cargill was additionally charged with failure to supervise. In a separate case, Port 22 LLC consented to pay a fine of US $55,000 for engaging in a pattern of trading between June 8, 2013, and June 11, 2014, whereby the firm did not correct a software bug that caused misleading bids and offers to be sent to the market. According to CME Group, during this time, Port 22’s automated trading system entered price modifications in Eurodollar futures spread instruments that incrementally widened bids and offers. Port 22 noticed this problem while first testing its ATS, but failed to take adequate steps to remedy it, and then failed to fix the problem for eight months after it was first notified by the exchange of the issue. CME Group charged the firm with engaging in acts “detrimental to the interest or welfare of the Exchange,” and for failure to supervise.
Compliance Weeds: Transfers of positions from one account to another with the identical beneficial ownership should be accomplished applying exchange rules related to transfers of trades not through pre-arranged trades. (Click here to access CME Group Rule 853.A.1.i)
- Court Rules CFTC Lawsuit Against Multiple Clients' Attorney May Proceed: A US federal court in Florida declined to dismiss a complaint filed by the Commodity Futures Trading Commission that alleged that Jay Grossman, an attorney, aided and abetted violations of law by multiple clients. The CFTC filed charges against Mr. Grossman during September 2014, claiming that he helped four of his clients—who allegedly held themselves out to the public as metals clearing firms—to engage in unlawful off-exchange retail commodity transactions and fraud. These firms included Hunter Wise Commodities, LLC and related entities. The CFTC also charged Mr. Grossman with assisting similar violations by other clients too. According to the CFTC, Mr. Grossman’s “role went well beyond the provision of legal advice” in connection with assistance to Hunter Wise and the other companies. Mr. Grossman had sought to have the CFTC’s charges dismissed, claiming that, “he was merely providing legal advice to his clients, and, therefore, can’t be subject to liability.” However, the court rejected Mr. Grossman’s position, saying that his argument is a “factual one, one which brushes off the well-pleaded allegations found in the Complaint.” As a result, it was not appropriate, to dismiss the CFTC’s complaint, wrote the court. (Click here for further information on the initial CFTC complaint in the article, “CFTC Sues Lawyer in Federal Court for Aiding and Abetting Clients’ Legal Violations,” in the September 8 to 12 and 15, 2014 edition of Bridging the Week.)
- CPMI and IOSCO Propose Uniform Disclosure Standards for CCPs: The Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions proposed standardized disclosures by clearinghouses to enable stakeholders to more adequately compare the entities’ risks, risk controls and systemic importance. The disclosures require, among other things, basic quantitative data (presented in a common template) regarding transaction volumes and values, resources to withstand possible losses, settlement timeliness and other performance-related statistics. Most information should be updated quarterly or annually. Among specific information recommended to be disclosed are (1) total value of default resources (excluding initial and variation margin), distinguished by pre-funded and committed resources; (2) stress test findings regarding largest aggregate loss in excess of initial margin caused by the default of a single participant and affiliates, and any two participants and affiliates; (3) type of initial margin model used; (4) default rules and principles; and (5) open interest and initial margin concentration metrics for the largest clearing members (on an anonymous and aggregate basis). CPMI operates under the umbrella of the Bank for International Settlements.
- NY-Based Broker-Dealer Sanctioned by FINRA for Not Having Adequate Procedures to Ensure Employee Did Not Trade on Insider Information: First New York Securities LLC was fined US $400,000 for failing to have adequate systems and controls to detect insider trading by Kenneth Allen, a former proprietary trader, while he possessed material, nonpublic information. During early 2010, Mr. Allen retained an outside consultant to provide him information on the Japanese market that First New York paid from Mr. Allen’s compensation. In September 2010, this consultant advised Mr. Allen that he learned through an employee in the sales department of Nomura Securities Co. Ltd. that Tokyo Electric Power Company would announce a secondary public offering underwritten by Nomura on September 29, 2010. This would likely result in TEPCO’s stock price falling. In response, Mr. Allen sold short TEPCO shares for First New York, which he later bought back on September 29 and October 1, 2o10, after the announcement of the offering on September 29. The trading had involved an accumulation of an 80,000-share short position, “one of the largest positions [Mr.] Allen had taken in a security while at First New York.” Although First New York’s procedures contained a policy statement that required the firm’s chief compliance officer to review, at least monthly, a sample of trading in the firm’s proprietary account, it did not describe how this review should occur, including “the identification of red flags indicative of possible insider trading.” These red flags, said FINRA, should have included “trading before a news announcement, the size of positions in certain stocks, and the amount of profits generated as a result of trading in advance of a news event.” FINRA also claimed that the firm’s review of Mr. Allen’s electronic communications was inadequate, as there were numerous suspicious communications regarding Mr. Allen’s illicit activities that never were detected. First New York previously paid a fine of JPY 14.7 million (approximately US $150,000) related to this incident for violating Japan’s insider trading laws.
- Asset Managers Warned to Avoid Conflicts by SEC Asset Management Unit Co-Chief…: Julie Riewe, Co-Chief, Asset Management Unit (AMU) for the Division of Enforcement of the Securities and Exchange Commission, discussed the priorities for AMU during IA Watch’s 17th annual Investment Adviser Compliance Conference in Washington, DC, last week. Principal among the AMU’s enforcement priorities are to ensure that all advisers discharge their “fiduciary obligation” to identify conflicts of interests and to “mitigate them and disclose their existence to boards or investors.” Among the specific conflicts AMU identified in recent enforcement actions were failure to obtain best execution, by registered funds; principal transactions without obligatory written disclosure and consent, by hedge funds; and fee and expense arrangements, by private funds (e.g., an adviser misallocating expenses to funds it managed). Ms. Riewe claimed that, among registered investment advisers, the most significant conflicts of interest involve improper principal transactions, the failure of best execution by related broker-dealers and non-disclosed compensation arrangements. According to Ms. Riewe, going forward AMU will “recommend a number of conflicts cases for enforcement action, including matters involving best execution failures in the share class context, undisclosed outside business activities, related-party transactions, fee and expense misallocation issues in the private fund context, and undisclosed bias toward proprietary products and investments.”
- …FCA Fines Investment Manager for Conflicts: The UK Financial Conduct Authority fined Aviva Investors, an asset management company that is part of the Aviva Group, GBP 17. 6 million (approximately US $27.2 million) for not adequately managing conflicts of interests fairly. According to FCA, from August 20, 2005, to June 30, 2013, Aviva employed fixed income traders that worked side-by-side to execute transactions for different funds that paid different levels of performance fees. This created incentives, claimed FCA, for the same traders to favor one fund over another, when the same instruments were transacted. Because of this practice, and weaknesses in Aviva’s post-trade allocation processes that enabled traders to delay allocation of trades intraday until after assessing favorable price moves (i.e., engage in a practice known as “cherry picking”), in May 2013, Aviva paid GBP 132 million (approximately US $203.8 million) to eight funds it managed “that may have been adversely impacted as a result of Aviva Investors’ poor control environment.” Aviva’s internal audit function identified elements relevant to these control weaknesses during four audits during the relevant time, but “steps taken by the Firm failed to adequately address them,” said FCA. In settling this matter with Aviva, FCA noted that the firm has worked openly and cooperatively with FCA and has expended “significant resources” to investigate and fix its control weaknesses.
And even more briefly:
- Déjà vu All Over Again: CFTC Reopens Comment Period on Position Limits and Aggregation: The Commodity Futures Trading Commission re-opened the comment period regarding its latest proposed new rules regarding position limits and aggregation. The new comment period closes on March 28. (Click here for a summary of the CFTC’s proposed new rules in the article, “CFTC Proposes New Position Limit Rules: Addresses Absolute Limits of 28 Core Futures Products, Aggregation, and Bona Fide Hedging” in the November 5, 2013 edition of what is now known as Between Bridges.)
- Fed Extends to April 3 Comment Period for Proposal to Levy Capital Surcharges for Largest Banks: The Board of Governors of the Federal Reserve System has extended until April 3 the comment period related to its proposed implementation of risk-based capital surcharges for US-based, global, systemically important banking organizations.
- ESMA Criticizes European Regulators for Not Implementing Best Execution Requirements: The European Securities and Markets Authority issued a peer review that found significant fault with the implementation by individual national regulators in Europe of a pan-European best execution regime related to equities and bonds as contemplated by the Markets in Financial Instruments Directive. In general, said ESMA, national authorities tend to use local markets as the proxy to assess best execution; analyze best execution only in terms of the best price as opposed to other execution factors (even where several execution markets are available); and contemplate best execution only in terms of shares, not bonds. Under MiFID, best execution involves obtaining “the best possible result for … clients, taking into account, price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to order execution.” (Click here for further information in “Best Execution under MiFID,” by The Committee of European Securities Regulators (May 2007).)
- ISDA Recommends Measures to Enhance Derivatives Trade Reporting and Transparency: The International Swaps and Derivatives Association has proposed measures to further improve regulatory transparency and trade reporting of derivative transactions. Among other measures, ISDA recommends that regulators worldwide implement consistent reporting requirements with common trade data and that unique global identifiers for legal entities, product types and trades be “expanded as necessary” and “adopted across reporting regimes.” Moreover, jurisdictions should address laws and regulations that prevent the sharing of derivatives of trade data across geopolitical boundaries.
- Canadian Regulators Not High on Medical Marijuana Industry Disclosures: The Canadian Securities Administrators roundly criticized the disclosures of “certain reporting issuers” proposing to enter Canada’s medical marijuana industry. Typically, these companies propose to enter this industry in response to the Canadian government’s passage of the Marihuana for Medical Purposes Regulations that became effective in April 2014. CSA’s review covered 62 issuers. According to CSA, 40 percent of these issuers “raised serious investor protection concerns related to balanced disclosure.” Among other things, said CSA, “[w]hile the benefits associated with involvement in the medical marijuana industry were often discussed, these discussions were not consistently accompanied by disclosure about the risks, uncertainties, cost implications and time required before the issuer can begin licensed operations.” As a result, said CSA, “[w]e were disappointed at the level of deficiency identified in the original announcements by issuers.” Of all issuers within the scope of CSA’s review, 92 percent were required to file a clarifying disclosure document, which they did.
Totally Irrelevant (But Is It): Perhaps this may be a good example of the grass not always being greener on the other side (of the border)—at least when it comes to disclosures!
For more information, see:
Asset Managers Warned to Avoid Conflicts by SEC Asset Management Unit Co-Chief…:
Bank of England Report Finds Positive Impact on UK Equities Markets by High Frequency Traders:
Canadian Regulators Not High on Medical Marijuana Industry Disclosures:
CME Group Sanctions Firm and Traders for Wash Trades Used to Transfer Positions and Another Firm for a Deficient Algorithm:
Cargill de Mexico:
Port 22 LLC:
Court Rules CFTC Lawsuit Against Multiple Clients' Attorney May Proceed:
CPMI and IOSCO Propose Uniform Disclosure Standards for CCPs:
Déjà vu All Over Again: CFTC Reopens Comment Period on Position Limits and Aggregation:
ESMA Criticizes European Regulators for Not Implementing Best Execution Requirements:
Europe and US Receive Good Grades for PFMI Implementation; Japan Receives the Best Grade:
…FCA Fines Investment Manager for Conflicts:
Fed Extends to April 3 Comment Period for Proposal to Levy Capital Surcharges for Largest Banks:
ISDA Recommends Measures to Enhance Derivatives Trade Reporting and Transparency:
NY-Based Broker-Dealer Sanctioned by FINRA for Not Having Adequate Procedures to Ensure Employee Did Not Trade on Insider Information:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of February 28, 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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