June 27, 2017
Senate Appropriations Subcommittee on Financial Services and Government: Review of the FY2018 Budget Requests for the SEC & CFTC
Key Topics and Takeaways
- Markets in Financial Instruments Directive II: Securities and Exchange Commissioner (SEC) Chairman Jay Clayton received multiple questions on the Markets in Financial Instruments Directive II (MiFID II), an E.U. financial regulation that would impact U.S. broker dealers that accept soft dollars for research from European asset managers. Sen. Jerry Moran (R-Kan.) asked Clayton if he was aware of the issue, and Sen. John Boozman (R-Ark.) asked Clayton if there was anything “hindering” his ability to provide temporary relief. Clayton assured the Senators that the issue was being evaluated by SEC staff, and that he was concerned that small and mid-cap companies could have their research coverage hurt by the rule. Clayton also said that “The amount of relief that may be necessary may depend on the amount of cooperation we receive from our European counterparts.”
- Inter-affiliate Margin: Commodities Futures Trading Commission (CFTC) Acting Chairman Christopher Giancarlo said that the CFTC supported the Inter-affiliate margin exemption and would try to impress upon U.S. prudential regulators the concerns of impacted firms. Boozman noted that the failure of the prudential regulators to grant a similar exemption has tied up billions of dollars in capital unnecessarily and created an unlevel playing field for U.S. firms.
- Swap Dealer de minimus: Giancarlo also said that the CFTC is gathering data on the potential impact of drop in the de minimus threshold, and said that once the agency has this data it will able to find the right level to set the threshold at. Giancarlo also said the CFTC would have the data in time to make a decision on the threshold level before the planned threshold change date.
- The Honorable Jay Clayton, Chairman, U.S. Securities and Exchange Commission
- The Honorable J. Christopher Giancarlo, Acting Chairman, Commodities Futures Trading Commission
In her opening statement, Subcommittee Chairman Shelley Moore Capito (R-W.Va.) gave an overview of the Securities Exchange Commission (SEC) and Commodity Futures Trading Commission’s (CFTC’s) budget requests. Capito said that the funding will ultimately come from fees passed along to investors, and said it was important that these fees be reasonable. Capito was also concerned about the ability of the CFTC and SEC to handle cybersecurity threats and the possibility that the regulatory burden on investors would be increased in the future.
In his opening statement, Subcommittee Ranking Member Christopher Coons (D-Del.) said that the CFTC and SEC must be properly funded to provide “vigilant oversight” of markets to protect investors. Coons also said it is critical that the regulatory failures of 2008 not repeat. Coons said that he hopes the budgets of the CFTC and SEC are sufficient to ensure that U.S. financial markets are fair and efficient.
The Honorable Jay Clayton, Chairman, U.S. Securities and Exchange Commission
In his testimony, Clayton said the SEC was requesting $1.602 billion for FY 2018, which is essentially the same as was asked in FY 2017. In FY17, the SEC oversaw $75 trillion in equities traded, and monitored 8,800 public companies, including 77 of the world’s 100 largest companies. Clayton also said that the SEC’s “modest” fee of two cents per $1,000 traded should remain in place. Clayton raised five main points that he wants to address in this budget, which were: 1) effective agency management; 2) protecting investors; 3) facilitating capital formation; 4) leveraging technology; and 5) leasing agreements. Clayton also said the agency will expend significant resources on market surveillance and enforcement.
The Honorable J. Christopher Giancarlo, Acting Chairman, Commodities Futures Trading Commission
In his testimony, Giancarlo said that his agency is integral to maintaining stability in commodities markets, which are critical for companies to hedge risk. Giancarlo said U.S. markets are currently “more concentrated and less liquid” than in previous years and that as Chairman he will take steps to increase investment. Giancarlo asked for a $31.5 million increase in the budget over the President’s proposed FY18 budget request (the President’s FY18 budget requested $250 million for the CFTC; Giancarlo requested $281.5 million). Giancarlo said his main priorities as Chairman were: 1) to bulk up the underfunded office of the Chief Economist; 2) to increase regulatory oversight on derivative clearinghouses; and 3) to keep pace with emerging technologies used in the marketplace.
Question and Answer
Sen. Jerry Moran (R-Kan.) asked how the SEC intends to respond to the EU’s new MiFID II requirements that will impact the ability of broker-dealers to accept direct payments for research. Moran noted that small companies may lose access to research coverage under the new regime. Clayton said that the SEC was also concerned about any reduction in research coverage, and said that the agency is “looking at this” and is engaged with its European counterparts on the issue. Moran told Clayton that the agency could count on Congressional support for a resolution to the issue that would support small business.
Sen. John Boozman (R-Ark.) also asked about the negative impact of MiFID II in the U.S. Boozman said that he understood the SEC is looking in to the issue, but asked whether the SEC could provide short-term relief while a permanent solution is sought. Boozman specifically asked if there was anything “hindering” Clayton’s ability to provide relief. Clayton said he was “not certain” that the agency could provide “all the relief people might want” but reiterated that the SEC’s staff is engaged on the issue and aware of its possible impact. Clayton also said that “The amount of relief that may be necessary may depend on the amount of cooperation we receive from our European counterparts.” Boozman praised the agency’s awareness of the issue but said that it may “need to turn that awareness into action.”
Boozman noted that in the CFTC’s final rules for swap margin requirements, the agency granted an exemption to inter-affiliate swaps, but that prudential banking regulators (the Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Federal Reserve) did not. Boozman said their failure to grant a similar exemption has tied up billions of dollars in capital unnecessarily and created an unlevel playing field, as the EU and Japan also granted an exemption to inter-affiliate swaps. Boozman asked Giancarlo if he supported a legislative exemption for inter-affiliate swaps, and if such an exemption would be positive for markets. Giancarlo said that inter-affiliate swaps were not an issue during the 2008 financial crisis, and that he wants to make U.S. banking regulators more sensitive to the concerns of American firms. Giancarlo noted many U.S. firms have been prevented from entering global swaps markets due to the inter-affiliate margin requirements.
Swap Dealer De Minimus
Moran noted that the swap dealer de minimus threshold is set to drop to $3 billion from $8 billion this year, and that this change would hurt farmers and end users. Moran asked Giancarlo to commit to keeping the de minimus threshold at the current $8 billion level. Giancarlo said that the CFTC is gathering data on the potential impact of the change in the de minimus threshold and said that once the agency has this data it will able to find the right level to set the threshold. Giancarlo also said the CFTC would have the data to make a decision before the drop in the de minimus threshold occurs.
Fiduciary Duty Rule
Moran expressed concern about the impact of the Department of Labor’s Fiduciary Duty rule on investor options and access to advice, and asked what the SEC is doing to protect investors and ensure that regulators are not working at cross-purposes. Clayton said that the SEC recently put out a request for information on the rule, as it impacts markets regulated by the SEC. Clayton said the SEC wants to preserve investor access to advice, products, and protection in a “coordinated way.”
Coons asked Giancarlo what the impact would be if the CFTC does not receive the $280 million that he requested and instead receives the FY18 budget’s proposed $250 million. Giancarlo said that it is important that the CFTC hire new economists to track marketplaces and that the agency “really needs” the technology budget increase.
Coons asked Clayton if the SEC could continue fulfilling its mission with a roughly two percent in spending cut from each operating division at his agency. Clayton said he was “comfortable” the SEC can fulfill its mission with the lower funding level, but did not rule out future budget increases. Clayton also said he wants to keep the SEC’s reserve fund at the $50 million level.
Sen. Steve Daines (R-Mont.) noted that CFTC Commissioner Sharon Bowen announced her retirement, and asked Giancarlo for his view of the impact on the agency of not having a full commission. Giancarlo said he supported a full five-person commission.
Coons asked Giancarlo and Clayton to describe their plans for investing in cybersecurity at their respective agencies. Giancarlo said cybersecurity was his “number one priority” and that should the CFTC not receive the funding it wants, it will prioritize cybersecurity over other areas. Clayton said that cybersecurity was also a priority for him and the SEC, given the agency provides “critical functionality” for markets online.
Capito asked Clayton for his thoughts on the decline in the number of public companies listed on U.S. exchanges. Clayton said that the regulatory costs borne by publicly-traded companies, in addition to the relative ease of raising capital from private investors and the weak liquidity of small and mid-cap company’s shares are all deterrents.
Capito later asked if the transparency around derivatives trading has improved because of the Dodd-Frank Act, and Clayton said that moving trading within clearinghouses has improved transparency. Clayton also said he was satisfied that the FY18 budget request for the SEC would allow the agency to meet its transparency goals.
Daines brought up about a recent report from the Brookings Institute that showed that over the last 10 years, the number of Futures Commission Merchants (FCMs) has fallen from 171 to just 64, representing a high degree of market consolidation. Daines asked Giancarlo for his thoughts on the practical impact in the reduction in the number of FCMs. Giancarlo said that low interest rates and financial mismanagement have made some FCMs fail, but said there was â€œno questionâ€ that “misdesigned regulation and overregulation” contributed to the decline in FCMs. Giancarlo noted that the Treasury’s report called for two adjustments that could help reverse the trend.
Boozman asked Giancarlo if he would review how international and U.S. regulations have created duplicative and conflicting regulatory regimes for U.S. firms, and if regulatory conflict has deterred firms from entering U.S. markets. Giancarlo said this was a critical and â€œchallengingâ€ issue and that the CFTC has tried to harmonize domestic with international regulations when possible.
Boozman also asked Clayton if the SEC intended to work with the Treasury on adjusting regulations as recommended in its recent report, specifically on the Currently Expected Credit Loss (CECL) rules from the Financial Accounting Standards Board (FASB). Clayton said the agency was exploring what the operational impact would be of the new standards, as he wants to make sure it does not have an “adverse impact” on lending.
For more information on this hearing, please click here.