During the past four years, the Commodity Futures Trading Commission (“CFTC” or the “Commission”) has substantially expanded its regulatory reach and flexed stronger enforcement muscles. Since 2010, the CFTC has dramatically increased its annual enforcement action totals, and has imposed record high financial penalties on significant market participants. In 2011 and 2012, the CFTC filed at least 201 enforcement actions, almost as many as the past five years combined, and has already recovered approximately $1.8 billion in total sanctions. As CFTC Chairman Gary Gensler has stated, “Dodd-Frank expands the CFTC’s arsenal of enforcement tools. We will use these tools to be a more effective cop on the beat, to promote market integrity, and to protect market participants.” Notwithstanding budgetary constraints, the next four years are likely to show continued emphasis on expanded enforcement efforts as the agency implements its new rules. This post focuses on the CFTC’s new rulemakings and how Title VII has increased the CFTC’s power to create and police the derivatives markets.

I. Expanding the CFTC’s Enforcement Actions

Over the past two years, the agency has hit record levels of enforcement actions and civil penalties imposed. Figure 1 below details the types of enforcement actions that the CFTC has brought from 2006 through 2012, as well as the total amounts of monetary penalties it recovered during each fiscal year.

…continue reading: The Changing Landscape of the CFTC’s Enforcement Actions

Today [May 1, 2013], the Commission considers issuing a release proposing rules and interpretive guidance applicable to certain market intermediaries, participants, clearing agencies, data repositories, and trade execution facilities that are involved in cross-border transactions of security-based swaps. The proposed release is over 1,000 pages, contains over 2,000 footnotes, and requests comments on more than 630 questions with many subparts. Although the questions posed are many, they are intended to be balanced and fair to solicit views from all sides. This is a welcome approach, because it contributes to a healthy debate and dialogue that is vital to the Commission’s processes.

Today, the Commission also votes to reopen the comment period on the various outstanding rulemaking releases and policy statement concerning security-based swaps and market participants to allow the public additional time to analyze and provide comments in light of our cross-border release.

The length of the cross-border release and the reopening of the comment periods reflect the complexity and importance of the issues involved in securities-based swap transactions. In issuing today’s proposal and asking for comments on the Commission’s proposed approach to regulating the securities-based swap market, the Commission recognizes the interactions among many important rules in this area. It is important, therefore, that our rules avoid gaps and loopholes, and that they work together to provide the needed transparency, accountability, and protection to our economy, the markets, and, most importantly, to investors.

…continue reading: Proposed Rules for Global Derivatives Market

Scholars have traditionally assumed that lenders that protect themselves using credit derivatives like credit default swaps (CDS) have limited interest in debt governance. The rationale behind this proposition seems straight-forward. Lenders that have bought credit protection should have little incentive to invest in monitoring and disciplining a borrower where they know they will be repaid under the CDS. Indeed, scholars argue, lenders that have purchased CDS protection have considerable interest in seeing a borrower fail. When this happens, they can easily and cheaply exit their investment by triggering repayment on the CDS.

This paper, the New Market in Debt Governance, recently made available on SSRN, challenges this consensus and proposes a new theory of governance in the context of credit derivatives trading. While scholars have traditionally focused on lenders that protect themselves using CDS, they overlook the role of financial firms that sell this credit protection and thereby assume economic risk on the underlying borrower. These protection sellers take on the risk of a borrower defaulting, but possess no legal tools with which they can discipline the borrower to stave off default. As a result, unlike ordinary lenders, protection sellers have no direct means to control a borrower’s risk-taking. They possess no legal powers to influence how much leverage a borrower takes on, its use of collateral, cash reserves or its acquisitions and enterprise strategy. Given this precarious position, it follows that protection sellers possess powerful incentives to seek out ways to influence how a borrower company is run to better control how risky it is allowed to become.

…continue reading: The New Market in Debt Governance

The New Era of Swaps Market Reform

This hearing is occurring at an historic time in the markets. The CFTC now oversees the derivatives marketplace — across both futures and swaps. The marketplace is increasingly shifting to implementation of the common-sense rules of the road for the swaps market that Congress included in the Dodd-Frank Act.

For the first time, the public is benefiting from seeing the price and volume of each swap transaction. This post-trade transparency builds upon what has worked for decades in the futures and securities markets. The new swaps market information is available free of charge on a website, like a modern-day ticker tape.

For the first time, the public will benefit from the greater access to the markets and the risk reduction that comes with central clearing. Required clearing of interest rate and credit index swaps between financial entities begins next month.

For the first time, the public will benefit from specific oversight of swap dealers. As of today, 71 swap dealers are provisionally registered. They are subject to standards for sales practices, recordkeeping and business conduct to help lower risk to the economy and protect the public from fraud and manipulation. The full list of registered swap dealers is on the CFTC’s website, and we will update it as more entities register.

…continue reading: CFTC’s Progress on Wall Street Reform

On December 21, 2012, the Italian Parliament approved the budget law for 2013 (the “Budget Law”) contemplating, among other things, the introduction of a new tax applicable to certain financial transactions (the “Financial Transaction Tax” or “FTT”).

While the Budget Law includes an articulate regime of the FTT, ”some of its features will be set with a Ministerial Decree to be issued by the Ministry of Economy and Finance (the “Ministerial Decree”) within 30 days from the entry in force of the Budget Law (which is subject to its publication in the Official Gazette, expected to occur in the coming days).

…continue reading: Italy Introduces a Financial Transaction Tax as of 2013

Nearly three years after the U.S. Securities and Exchange Commission (“SEC”) effectively froze the creation of actively managed and leveraged exchange traded funds (“ETFs”) that utilize options, futures, swaps, and other derivatives as part of their investment strategies, the SEC has lifted the moratorium on the use of derivatives by actively managed funds while continuing to restrict the use of derivatives by leveraged ETFs. The SEC’s decision follows a Concept Release issued last August soliciting comments on the issue from the public. ETFs, which are typically registered as open-ended investment companies under the Investment Company Act of 1940 (the “’40 Act”), usually require exemptive relief from the SEC because certain common features of ETFs do not comport with the strict provisions of the ’40 Act.

On December 6, 2012, in a speech to the American Law Institute’s Conference on Investment Adviser Regulation in New York City, Norm Champ, Director of the Division of Investment Management, announced the SEC has reversed course and “will no longer defer consideration of exemptive requests under the Investment Company Act relating to actively managed ETFs that make use of derivatives.” In his speech, Director Champ made clear the SEC’s decision was subject to two important conditions, each designed to address the concerns by the SEC back in March 2010 when it first imposed the moratorium on derivatives. To that end, issuers seeking to create an actively managed ETF that employs derivatives will be required to represent: “(i) that the ETF’s board periodically will review and approve the ETF’s use of derivatives and how the ETF’s investment adviser assesses and manages risk with respect to the ETF’s use of derivatives; and (ii) that the ETF’s disclosure of its use of derivatives in its offering documents and periodic reports is consistent with relevant Commission and staff guidance.”

…continue reading: SEC and Actively Managed Exchange Traded Funds

On November 16, 2012, the Secretary of the Treasury issued a much awaited determination that foreign exchange (“FX”) swaps and FX forwards should not be regulated as swaps under the Commodity Exchange Act for most purposes, including registration, mandatory clearing and trade execution, and margin. As was the case in the proposed determination, FX derivatives other than FX swaps and forwards, such as FX options, currency swaps and non-deliverable forwards, are not covered by the exemption and would be regulated as swaps.

FX swaps and forwards will be subject to swap data repository trade reporting requirements applicable to swaps and to historical swaps. They will not be subject to “real-time” trade reporting requirements, however. Furthermore, the Commodity Futures Trading Commission’s enhanced anti-evasion authority will apply to FX swaps and forwards. In addition, swap dealers and major swap participants transacting in FX swaps and forwards must comply with “business conduct standards” contained in Section 4s(h) of the Commodity Exchange Act and implementing regulations. [1] These include the external business conduct rules, which impose on swap dealers and major swap participants various due diligence, fair dealing and disclosure obligations, certain heightened obligations when dealing with “special entities” and, in the case of swap dealers recommending swaps or swap trading strategies, suitability obligations. They also include the CFTC’s internal business conduct rules relating to diligent supervision. Finally, in discussing enhanced business conduct standards applicable to FX swaps and forwards, the final determination cites to the CFTC’s recently finalized rules on swap confirmation, portfolio reconciliation, portfolio compression and trading relationship documentation, which were adopted in part pursuant to Section 4s(h).

…continue reading: Treasury Issues FX Swap and FX Forward Exemption

In our recent paper, On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership, we build and explore a formal theoretical framework to understand interactions between derivatives markets and shareholder voting behavior.

Ownership of stock in a corporation entails two types of rights with respect to that corporation. First, shareholders have economic ownership rights that entitle them to share in corporate profits. Second, they have certain legal rights of control over the corporation. These economic and control rights come bound together with each share of stock, but they can be separated, or decoupled. Decoupling can result in empty voting, in which an actor’s voting interest in a corporation is larger than her economic interest. It can also lead to hidden ownership, in which an actor’s economic interest in a corporation exceeds her voting interest. Decoupling raises a host of concerns because it turns the conventional logic for granting shareholders voting rights—their economic interest in the corporation—on its head. (See references here.)

…continue reading: A Theory of Empty Voting and Hidden Ownership

As you may know, I am the Commission’s designated representative on the Financial Stability Board, or FSB, which is an international forum of prudential financial regulators, market regulators, international financial institutions and standard setting bodies. And last spring I finished a tour of duty as the Commission’s head of delegation to the International Organization of Securities Commissions, also known as IOSCO, a position now ably filled by the Commission’s Director of the Office of International Affairs, Ethiopis Tafara. The experience I have had representing the Commission in these institutions has been enlightening. While I, like most people, already understood that we are living in an increasingly interconnected world, serving on IOSCO and the FSB has helped me better appreciate the extent of these connections in the financial system, as well as both the power and the limitations of these international forums.

One of the better-known achievements of IOSCO is how it has increased international cooperation among securities regulators in the area of enforcement. This cooperation has been extraordinarily valuable, facilitating countless Commission cases where crucial evidence rests outside of the United States. Building on this success, we are now establishing cooperative arrangements with other regulators in our supervision program.

…continue reading: International Coordination Among Regulators

I. Introduction

Almost four years after the financial crisis and over two years after the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the overhaul of the US derivatives market is rapidly shifting into the implementation phase. Many of the key elements of Dodd-Frank relating to OTC derivatives will begin to take effect on October 12, 2012, although the CFTC has delayed implementation of some requirements until the beginning of 2013.

Under Dodd-Frank, Swap Dealers, Security-Based Swap Dealers, Major Swap Participants (“MSPs”) and Major Security-Based Swap Participants must register with the CFTC or SEC, as appropriate, and thereafter will be subject to strict regulation. Swap Dealers and MSPs will be required to comply with, among other things, regulations governing minimum margin and capital requirements, mandatory clearing and exchange trading of swaps and security-based swaps, swap reporting and recordkeeping requirements, internal and external business conduct standards and position limits. Even for companies that are not Swap Dealers or MSPs, are predominantly engaged in non-financial activity, and are using swaps or security-based swaps to hedge or mitigate commercial risk (“End-Users”), compliance with Dodd-Frank presents a significant challenge.

…continue reading: A Corporate End-User’s Handbook for Dodd-Frank Title VII Compliance