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IOSCO Issues Policy Recommendations for Money Market Funds

October 18, 2012 James Hardaway Jr. Compliance, Hedge Funds, Mutual Funds, Private Equity, Proposed Regulations

On October 7, 2012, the International Organization of Securities Commissions (IOSCO) issued policy recommendations requested by the Financial Stability Board (FSB) as part of the FSB’s plans to strengthen the oversight and regulation of the shadow banking system (see below), endorsed by the G20 Leaders in 2011. These recommendations supplement the existing frameworks where IOSCO considers there is still room for further reforms and improvements.

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The FSB’s mandate indicated that a key issue to be considered was the Constant Net Asset Value feature of some money market funds. In developing its policy recommendations, IOSCO considered this crucial question but also other aspects of MMF regulation where greater harmonization between jurisdictions and improvements to existing regulations were seen necessary. They stated that compared to the reforms introduced in 2010 which mainly focused on the asset side of funds, the present recommendations also address vulnerabilities arising from the liability side, as well as the crucial issue of valuation and the display of a constant NAV.

The report cited that the 2011 “slow-motion” or “quiet” run on U.S. MMFs that surfaced because of concerns about their exposure to European sovereign debt through their lending to European banks, illustrates the high and increasing responsiveness of money market funds’ investors to potential risks and the overall systemic importance of the sector. ICI data show that assets managed by prime money market funds reached $1.66 trillion on June 1, 2011 and declined by over $170 billion (10%) to $1.49 trillion on August 31, 2011. This episode tends to indicate that post-crisis regulation did not fully mitigate the systemic risks MMFs represent for the broader economy and the possibility of runs. In its 2011 annual report, the U.S. Financial Stability Oversight Council described MMFs as an important conduit through which “amplification of a [European sovereign debt] shock” could happen. Indeed, when concerns started to soar on European sovereign debt, the massive redemptions from money market funds harmed the functioning of money markets for other firms. It also led to significant pressures for European banks.

The IOSCO issued 15 Recommendations which received several comments from the ICI, mutual fund companies and interest groups. Most of their Recommendations are similar to SEC Rule 2a-7. Recommendation #1 adopts money market funds to the Collective Investment Scheme (CIS) international regulations. Recommendation #4 does not allow mark-to-market as the predominant pricing method for MMFs. Recommendation #10 adopts the floating NAV for MMFs, if workable.

Recommendation 1: Money market funds should be explicitly defined in CIS regulation.

Recommendation 2: Specific limitations should apply to the types of assets in which MMFs may invest and the risks they may take.

Recommendation 3: Regulators should closely monitor the development and use of other vehicles similar to money market funds (collective investment schemes or other types of securities).

Recommendation 4: Money market funds should comply with the general principle of fair value when valuing the securities held in their portfolios. Amortized cost method should only be used in limited circumstances.

Recommendation 5: MMF valuation practices should be reviewed by a third party as part of their periodic reviews of the funds accounts.

Recommendation 6: Money market funds should establish sound policies and procedures to know their investors.

Recommendation 7: Money market funds should hold a minimum amount of liquid assets to strengthen their ability to face redemptions and prevent fire sales.

Recommendation 8: Money market funds should periodically conduct appropriate stress testing.

Recommendation 9: Money market funds should have tools in place to deal with exceptional market conditions and substantial redemptions pressures.

Recommendation 10: MMFs that offer a stable NAV should be subject to measures designed to reduce the specific risks associated with their stable NAV feature and to internalize the costs arising from these risks. Regulators should require, where workable, a conversion to floating/ variable NAV. Alternatively, safeguards should be introduced to reinforce stable NAV MMFs’ resilience and ability to face significant redemptions.

Recommendation 11: MMF regulation should strengthen the obligations of the responsible entities regarding internal credit risk assessment practices and avoid any mechanistic reliance on external ratings.

Recommendation 12: Credit rating agencies supervisors should seek to ensure credit rating agencies make more explicit their current rating methodologies for money market funds.

Recommendation 13: MMF documentation should include a specific disclosure drawing investors’ attention to the absence of a capital guarantee and the possibility of principal loss.

Recommendation 14: MMFs’ disclosure to investors should include all necessary information regarding the funds’ practices in relation to valuation and the applicable procedures in times of stress.

Recommendation 15: When necessary, regulators should develop guidelines strengthening the framework applicable to the use of repos by money market funds, taking into account the outcome of current work on repo markets.

In October 2011, the FSB issued a report that defined shadow banking as “the system of credit intermediation that involves entities and activities outside the regular banking system.” They recommended focusing on entities and activities implying maturity/liquidity transformation, imperfect credit risk transfer and/or leverage. This report set the basis for the creation of five workstreams in charge of assessing the need for further regulatory action, the second of which deals with the regulatory reform of MMFs. Money market funds are investment products subject to securities markets regulation. They are considered part of the Shadow Banking System on the basis that they perform maturity and liquidity transformation and are important sources of short-term funding, particularly for banks. In contrast with bank deposits, MMFs do not have access to official support and backstop facilities, and, whereas they have little ability to absorb losses, they also do not have explicit support from sponsor companies.

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CFTC Proposal to Harmonize Registration of Mutual Funds Already Registered with SEC

June 22, 2012 James Hardaway Jr. Compliance, Hedge Funds, Mutual Funds, Proposed Regulations

On February 24, 2012, the CFTC issued proposed revisions to Part 4 of the Commodity Exchange Act (“CEA”), which aligned with all but one industry comment regarding dual registration with the SEC and the CFTC for investment advisers to mutual funds.

The CFTC concurrently, in relevant part, issued rules requiring certain SEC registered investment advisers to mutual funds to register with the CFTC as commodity pool operators (CPOs”). Section 4.22(a) requires CPOs to provide periodic monthly account statements to participants in the pools that they operate. Although some commenters suggested that the CFTC accept the reporting required under the SEC regulations because to prepare and provide monthly account statements would be burdensome. The CFTC determined not to propose relief regarding the content or timing of the monthly account statement, and stated that the information required to prepare the account statement should be readily available to the operator of an investment vehicle maintaining records of its trading activity and other operations in accordance with recordkeeping requirements under the CEA and applicable securities laws. Consequently, investment advisers to mutual funds should distribute to each participant in each pool that it operates an Account Statement presented in the form of a Statement of Income (Loss) and a Statement of Changes in Net Asset Value for the prescribed period. The Account Statement must be distributed monthly for pools with net assets of more than $500,000, and otherwise at least quarterly.The financial statements must be presented in accordance with generally accepted accounting principles, consistently applied. They suggested that registered investment companies will be able to satisfy the requirement to deliver account statements to participants by making such statements available on their internet web sites, thereby substantially reducing any burden under Section 4.22(a).

In addition, the CFTC decided that the inclusion of the tabular presentation of the calculation of the break-even point consistent with its regulations is a necessary disclosure because, among other requirements, it mandates a greater level of detail regarding brokerage fees and does not assume a specific rate of return. And that this results in meaningful disclosure through the break-even analysis and facilitates an investor’s assessment of a registered investment company that uses derivatives. Therefore, mutual funds include this breakeven-point information in their prospectus.

There are other “disclosure requirements under Part 4 of the CEA that were not addressed in the proposal which could be considered duplicative for these investment advisers. The CFTC requested comments on harmonizing these rules.

The CFTC did agree with commenters to exempt from Part 4, the following disclosure requirements: (i) the timing of delivery of Disclosure Documents to prospective participants; (ii) the signed acknowledgement requirement for receipt of Disclosure Documents; (iii) the cycle for updating Disclosure Documents; (iv) the timing of financial reporting to participants; (v) the requirement that a CPO maintain its books and records on site; (vi) the required disclosure of fees; (vii) the required disclosure of past performance; (viii) the inclusion of mandatory certification language; (ix) and the SEC-permitted use of a summary prospectus of open-ended registered investment companies.

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IOSCO Issues Proposal on Valuation of Assets and Shares of Collective Investment Schemes

March 1, 2012 James Hardaway Jr. Compliance, Mutual Funds, Proposed Regulations

On February 12, 2012 the Technical Committee of the International Organizations of Securities Commissions (“IOSCO”) issued a draft consultation report to expound on its May 1999 final report on principles for valuation of collective investment schemes (“CIS”). The objectives of the May 1999 report were to obtain a greater understanding of the jurisdictional differences and regulator approaches to the valuation of CIS (mutual funds) and pricing of CIS interests; and gain an understanding of the extent and type of enforcement of jurisdictional rules relating to the valuation and pricing of CIS. Also, they recommended some ethical, disclosure and share calculation principles.

The Technical Committee consists of the chairpersons of the SEC and CFTC. And other government directors of securities regulation which include: Spain, UK, Japan, Germany, France, Italy, Mexico, Switzerland, Quebec, Ontario, China, Brazil and Australia.

Comments are due on or before May 18, 2012 and were specifically requested on the following:

Do these principles adequately address the regulatory issues raised by the valuation of CIS?
Are potential conflicts of interest appropriately addressed? Do you see a need for more stringent principles in this area?
In particular, does the principle on the NAV at which the purchase and redemption of CIS interests should be effected, adequately cover the issues.

In the February 2012 report the Committee proposed 13 principles on pricing mutual funds or CIS. Principles 1 to 5 are recommendations for written pricing policies and procedures for the securities or assets held by a CIS. They should identify the methodologies that will be used to value each asset held by the CIS. Structured financial instruments should be based on qualitative and quantitative analyses which have to be conducted both in normal and stress scenarios.

Principle 3 listed the following approaches to address the investment adviser conflicts of interest: (1) the risk management function of the CIS could review the valuation provided by the CIS operator. Under this model, the risk management function would be hierarchically and functionally independent of the CIS portfolio management function. Similarly, an internal auditor or committee that is separate from the CIS portfolio management function could review the valuations; (2) the portfolio management function could be separated from the valuation and/or pricing function, and thus not permit the CIS operator or portfolio manager to determine the valuations, although the CIS operator may be able to provide input, as appropriate. In addition, automating the valuation process, where possible, can help to reduce the possibility of improper influence on valuations; (3) the CIS depositary, as applicable, could seek to ensure that the CIS operator carries out the valuation of the CIS appropriately, therefore providing an independent check on the valuation policy and the way it is implemented; (4) the responsible entity could define and maintain a conflict of interests policy designed to manage conflicts associated with the valuation process, among other things; (5) the CIS could retain independent pricing services or other experts to assist them in obtaining independent valuations, as appropriate; (6) if the valuation is obtained from a third party that itself has a conflict of interest (i.e., the counterparty of an OTC derivative, the structurer or the originator), the verification of an appropriate degree of objectivity in the valuation could be carried out by one of the following: (i) an appropriate party which is independent from the third party, at an adequate frequency and in such a way that the responsible entity is able to check it; (ii) the depositary of the CIS; or (iii) a unit within the CIS which is independent from the department in charge of managing the assets and which is adequately equipped for such purpose.

Principle 4 states that the reasons for pricing overrides should be documented and reviewed by a party that is independent of the investment adviser or portfolio manager. Principle 5 stated that material pricing errors that cause harm to the investments should be compensated by the CIS.

Principles 6-8 proposes periodic review by the responsible entity of the pricing policies and procedures for appropriateness and effective implementation. Also, requires a third-party review of the process annually.

Principle 9 proposes that the responsible entity conducts initial and periodic due diligence on third party pricing services.

Principle 10 states that valuation procedures should be disclosed to investors about the CIS’s valuation policies and procedures could include general information about how certain assets are valued and how frequently they are valued. This information should be updated and made available to investors when these valuation policies and procedures materially change. For example, in the U.S., a CIS prospectus must disclose that the price of CIS shares is based on the CIS’s NAV and the methods used to value the CIS’s assets (e.g. market price, or amortized cost). For non-money market CIS, this disclosure must include a brief explanation of the circumstances under which it will use a price other than market price and the effects of using this price. The prospectus is updated annually or more frequently, depending on whether its information has changed materially. Other jurisdictions may require the CIS’s policy to include a specific section illustrating the criteria used to value the CIS assets. This information is then made available to investors upon request. In addition, certain valuation criteria are reported in the notes to the CIS/subCIS annual report.

Principle 11-13 adopts the U.S. forward pricing rule for CIS shares, and recommends that NAVs should be available to investors daily at no cost.

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FinCEN Releases Test Site for the New CTR and SAR

February 17, 2012 James Hardaway Jr. Compliance, Final Regulations, Hedge Funds, Private Equity, Proposed Regulations

Today, the Financial Crimes Enforcement Network (FinCEN) announced that it updated the BSA E-Filing System’s User Test System Web site to allow for testing submissions of batch and computer-to-computer filings of their new Currency Transaction Report (“CTR”) and Suspicious Activity Report (“SAR”).

The updates to the User Test System made available today will enable information technology (“IT”) professionals, including both vendors and the in-house IT staff of financial institutions, to begin testing their programs that will eventually be used to file batch or computer-to-computer submissions of the new reports based on the above-referenced technical specifications. The User Test System will begin to accept filings of these new reports in March 2012. The site will also make available and begin to accept the discrete filing of the PDF version of the reports on that same date. Institutions will not have the option to submit either of these new reports via paper.

FinCEN stated that in order to submit test files on the User Test System, a user account must be created which is specific to this site and separate from accounts used in the BSA E-Filing System. To set up an account on the User Test System, please click on “Become a BSA E-Filer” button within that site and follow the steps to enroll. Please be aware that the testing environment is separate and distinct from their BSA E-Filing system.

They recommended that the person who will be uploading the test file be listed in the User Information section at the top of the application. Within two business days, they will send to the approved user identified in the application an email containing the user ID and specific instructions on how to create and upload a test file.

FinCEN announced on December 20, 2011, that the mandatory use of these new reports will take effect on March 31, 2013. They will continue to accept submissions to its BSA E-Filing System that use the most current “legacy” forms (such as the CTR, CTR by Casinos, and industry-specific SARs) until the mandated use of the new reports in 2013. Accordingly, for approximately one year, financial institutions will be able to file either the legacy forms or the new reports.

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The OFR Directive to Implement Legal Entity Identifier for Financial Transactions

February 15, 2012 James Hardaway Jr. Compliance, Hedge Funds, Private Equity, Proposed Regulations

The Dodd-Frank Act established the Office of Financial Research (OFR) within the Treasury Department to improve the quality of financial data available to policymakers and facilitate more robust and sophisticated analysis of the financial system. One of its first directives was for an industry driven consensus on legal entity identification (“LEI”). The financial services industry, working through Global Financial Markets Association (“GFMA”), formed the Global Trade Association (GTA) group to formulate a proposal to the global industry. The GTA included firms from around the world and several regional and international trade associations. The objective was to develop a global, consensus-based solution for the accurate and unambiguous identification of legal entities engaged in financial transactions.

In July 2011, GTA presented the following recommendations:

Standards body- The International Organization for Standardization, i.e., ISO’s new standard, ISO 17442, is recommended for use as the new, authoritative legal entity identification standard.
Core Issuing and Facilities Manager – The Depository Trust & Clearing Corporation (DTCC) and the Society for Worldwide Interbank Financial Telecommunications (SWIFT), along with DTCC’s wholly-owned subsidiary AVOX Limited, are recommended as key partners to operate the core LEI utility as the central point for data collection, data maintenance, LEI assignment, and quality assurance.
Federated Registration – ANNA, through its network of 81 local national numbering agencies (NNAs), is recommended as a key partner in the solution for registering, validating and maintaining LEIs for issuers, obligors, and other relevant parties in the 118 home markets they serve. The NNAs are envisioned as the “face” of the LEI Utility to those markets while leveraging the functionality of the centralized LEI Utility for the assignment, further validation and global distribution of LEIs.

On January 12, 2012, the Financial Stability Board (“FSB”) formulated a private sector panel of advisers to the FSB LEI Expert Group of key stakeholders from the global regulatory community taking forward work on the Legal Entity Identifier initiative. The advisers are listed below.

Alfa-Bank

Alfred Sloan Foundation

Association of National Numbering Agencies (ANNA)

Brazilian Financial and Capital Markets Association

Corporation for National Research Initiatives

Depository Trust and Clearing Corporation (DTCC)

Enterprise Data Management Council (EDM)

European Banking Federation

Federation of Euro-Asian Stock Exchanges

German Investment and Asset Management Association (BVI)

GS1

S.D. Indeval S.A. de C.V.

ISITC Europe

Investment Management Association

International Organization for Standardization (ISO) Working Group 6 (LEI)

Japanese Bankers Association

Korean Financial Investment Association

Mexican Bankers Association

OpenCorporates

Risk Management Association

Society for Worldwide Interbank Financial Telecommunication (SWIFT)

Thomson Reuters

Tokyo Stock Exchange

Trade Repository Sub-group of the OTC Derivatives Working Group of the Treasury Market Association of Hong Kong

XBRL

CME Group

International DOI Foundation

Global Financial Markets Association

Investment Industry Association of Canada

International Organization for Standardization (ISO) Technical Committee 68

Japanese Securities Dealers Association

Regis-TR

J.M. Smucker Company

The Panel will assist the Expert Group in fulfilling the G-20 mandate “to prepare recommendations for the appropriate LEI governance framework, representing the public interest,” by the G-20 Summit in June 2012.

LEI will not replace existing entity identification codes, but will be added as the LEI authoritative entity identifier and mapped to other existing codes.

To be fully effective and avoid regulatory arbitrage, the LEI Solution is explicitly dependent upon global regulators consistently requiring the following: (i) in-scope legal entities register with the LEI Solution provider; (ii) in-scope legal entities maintain the accuracy and completeness of their data with such provider; (iii) in-scope transacting entities provide their LEI to counterparties with whom they are transacting (or otherwise make the LEI available where required for regulatory reporting by other financial market participants); (iv) in-scope non-transacting entities (i.e., reference entities; issuing entities; reporting entities; and other entities) provide LEI information as required by regulators; (v) a consistent definition of eligibility criteria for the issuance of an LEI; (vi) a consistent definition of in-scope entities.

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Qualified Advisers Must Register with the Municipal Securities Rulemaking Board

January 30, 2012 James Hardaway Jr. Compliance, Final Regulations, Hedge Funds, Proposed Regulations

The Municipal Securities Rulemaking Board has operated under a Congressional mandate with oversight by the Securities and Exchange Commission since 1975.

Amended Rule 15B(c)(1) of the Exchange Act states a municipal advisor and any person associated with such municipal advisor shall be deemed to have a fiduciary duty to any municipal entity for whom such municipal advisor acts as a municipal advisor, and no municipal advisor may engage in any act, practice, or course of business which is not consistent with a municipal advisor’s fiduciary duty or that is in contravention of any rule of the MSRB. Accordingly, the SEC directed the MSRB to issue rules for municipal advisors that “prescribe means reasonably designed to prevent acts, practices, and courses of business as are not consistent with a municipal advisor’s fiduciary duty to its clients. As a result, in February 2011 the MSRB issued proposed Rule G-36.

It would require a municipal advisor to make clear, written disclosure of all material conflicts of interest, such as those that might impair its ability to satisfy the duty of loyalty, and to receive the written informed consent of officials of the municipal entity with the authority to bind the municipal entity by contract with the municipal advisor. Such disclosure must be made before the municipal advisor may provide municipal advisory services to the municipal entity or, in the case of conflicts arising after the municipal advisory relationship has commenced, before the municipal advisor my continue to provide such services. In addition, a municipal advisor may not undertake an engagement if certain unmanageable conflicts exists. Including; (i) kickbacks and certain fee-splitting arrangements with the providers of investments or services to municipal entities, (ii) payments by municipal advisors made for the purpose of obtaining or retaining municipal advisory business other than reasonable fees paid to a municipal advisor for solicitation activities regulated by the MSRB, and (iii) acting as a principal in matters concerning the municipal advisory engagement (except when Internal Revenue Service competitive bidding guidelines for establishing fair market value are satisfied). The notice also provides that, in certain cases, the compensation received by a municipal advisor may be so disproportionate to the nature of the municipal advisory services performed that it is inconsistent with the Rule G-36 duty of loyalty and represents an unmanageable conflict, (iv) the notice provides that the Rule G-36 duty of care requires that a municipal advisor act competently and provide advice to the municipal entity after inquiry into reasonably feasible alternatives to the financings or products proposed (unless the engagement is of a limited nature). To date, this proposed rule has not been finalized.

Brokers, dealers, municipal securities dealers (collectively, municipal securities dealers) and municipal advisors must register with the MSRB before engaging in municipal securities and advisory activities. The terms broker, dealer, municipal securities dealer and municipal advisor are defined in the Securities Exchange Act of 1934 in sections 3(a)(4), 3(a)(5), 3(a)(30) and section 15B(e)(4), respectively. To register with the MSRB, all municipal securities dealers and municipal advisors must have an SEC registration number. Nonbank, municipal securities dealers also must have a FINRA registration number. MSRB Rules A-12 and A-14 requires them to pay an initial fee of $100 and an annual fee of $500, respectively. MSRB Rule G-40 requires registered municipal securities dealers and municipal advisors to appoint a primary contact to serve as the official contact person for purposes of electronic mail communications and to provide periodic updates to the MSRB. In the case of municipal securities dealers, the primary contact must be either a Series 53-registered municipal securities principal or a Series 51-registered municipal fund securities limited principal. Currently there are no requirements for municipal advisor primary contacts. Upon completion of its Rule A-12 submissions, the MSRB assigns a registration number. Each broker, dealer, municipal securities dealer, or municipal advisor shall review and, if necessary, update its information and submit such information electronically to the MSRB within 17 business days after the end of each calendar year. Each broker, dealer, municipal securities dealer, or municipal advisor shall promptly comply with any request by the appropriate regulatory agency for required information, but in any event not later than 15 days following any such request, or such longer period that may be agreed to by the appropriate regulatory agency. For municipal advisors, the categories of municipal advisors are derived from Form MA-T. Although, MSRB does not allow solicitation payment to non-affiliated persons of municipal broker dealers and principals, it does allow solicitation for municipal advisors.

In 2010 MSRB announced that they are adopting adopted a comprehensive set of rules for municipal advisors, as directed by the Dodd-Frank Act. As the rulemaking process proceeds, municipal providers will have the opportunity to provide input. Listed below are MSRB rules that currently apply to municipal advisors.

Rule A-12: Initial Fee
Rule A-14: Annual Fee
Rule A-16: Examination Fees
Rule D-11: Associated Persons
Rule D-13: Municipal Advisory Activities
Rule D-14: Appropriate Regulatory Agency
Rule G-1: Separately Identifiable Department or Division of a Bank
Rule G-3: Classification of Principals and Reps and Requirements
Rule G-5: Disciplinary Actions; Remedial Notices
Rule G-17: Conduct of Municipal Advisory Activities
Rule G-23: Activities of Financial Advisors
Rule G-24: Ue of Ownership Obtained in Fiduciary or Agency Capacity
Rule G-27: Supervision
Rule G-32: Disclosure in Relation to Private Offerings
Rule G-34: CUSIP No., New Issue, and Market Information Requirements
Rule G-37: Political Contributions and Prohibitions on Municipal Securities Business
Rule G-38: Solicitation of Municipal Securities Business
Rule G-40: Electronic Mail Contacts

The MSRB maintains the Electronic Municipal Market Access system (“EMMA”), a facility for receiving electronic submissions of municipal securities disclosure and other key documents and related information and for making such documents and information available to the public, at no charge at www.emma.msrb.org or by paid subscription. EMMA replaced the MSRB’s MSIL Facility in 2009, which previously served as the submission venue for official statements and continuing disclosures, and continues to operate in support of certain MSRB internal functions.

The Short-term Obligation Rate Transparency (“SHORT”) System is a facility of the Municipal Securities Rulemaking Board for the collection of information about securities bearing interest at short-term rates. Such information is made available to the public, at no charge, on the MSRB’s Electronic Municipal Market Access website. And the Real-time Transaction Reporting System (“RTRS”) is a facility for the collection and dissemination of information about transactions occurring in the municipal securities market. Most municipal securities transactions effected by brokers and dealers are reported to RTRS and are disseminated within 15 minutes of the time of trade execution. This data can be queried through the free EMMA website. Comprehensive data feeds are available through paid subscription.

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SEC Issues Extension for Registration of Municipal Advisers

January 27, 2012 James Hardaway Jr. Compliance, Final Regulations, Hedge Funds, Private Equity, Proposed Regulations

On September 26, 2012, the SEC extended the interim final temporary Rule 15Ba2-6T under the Exchange Act, which permits municipal adviser to temporarily satisfy the Dodd- Frank registration requirements, to September 30, 2013.

Previously, on December 21, 2011, the SEC extended the interim final temporary Rule 15Ba2-6T under the Exchange Act, to September 30, 2012.

Section 15B(a)(2) of the Exchange Act, as amended by Section 975(a)(2) of the Dodd-Frank Act, provides that a municipal adviser must be registered by filing with the SEC an application for registration in such form and containing such information and documents concerning the municipal advisor and any person associated with the municipal advisor as the SEC, by rule, may prescribe as necessary or appropriate in the public interest or for the protection of investors. Section 15B defines the term “municipal advisor” to mean a person (who is not a municipal entity or an employee of a municipal entity) (1) that provides advice to or on behalf of a municipal entity or obligated person with respect to “municipal financial products” or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues, or (2) that undertakes a “solicitation” of a municipal entity. The definition specifically includes financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and advisers that provide municipal advisory services. This definition specifically excludes underwriters of municipal securities. “Solicitation of a municipal entity or obligated person” is defined to mean a direct or indirect communication with a municipal entity or obligated person made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser as defined in Section 202 of the Investment Advisers Act of 1940, that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of a broker, dealer, municipal securities dealer, or municipal advisor for or in connection with municipal financial products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of a municipal entity. However, it should be noted that the MSRB only allows third-party solicitation for investment advisers who have to register as municipal advisers. MSRB Rule G-38 prohibits third-party solicitation for municipal broker dealers.

The term “municipal advisory services” as used herein means advice with respect to municipal financial products, the issuance of municipal securities, and the solicitation of a municipal entity. A registered investment adviser or an associated person of a registered investment adviser must register with the SEC as a municipal advisor if the adviser or associated person of an adviser provides any municipal advisory services other than investment advice within the meaning of the Investment Advisers Act. A commodity trading advisor or an associated person of a commodity trading advisor must register with the SEC as a municipal advisor if the commodity trading advisor or an associated person of a commodity trading advisor provides any municipal advisory services that are not advice related to swaps. The writes notes that the definition of associated municipal adviser professional is derived from the definition of “associated municipal finance professional” as set forth in MSRB Rule G-37.

Form MA-T requires a municipal advisor to indicate the purpose for which it is submitting the form (i.e., initial application for, or amendment or withdrawal of temporary registration), provide certain basic identifying and contact information concerning its business, indicate the nature of its municipal advisory activities, and supply information about its disciplinary history and the disciplinary history of its associated municipal advisor professionals. Disclosure is also required concerning any orders entered against the municipal advisor or any associated municipal advisor professional by any federal or state regulatory agency other than the SEC and Commodity Futures Trading Commission (“CFTC”) or by any foreign financial regulatory authority, within the last ten years. However, the writer noted that on the actual Form MA-T the term “ten years” was not listed. With respect to actions taken by self-regulatory organizations there is no time limit placed on disclosure. Section 975 of the Dodd-Frank Act amended section 15B of the Exchange Act directs the SEC, by order, to censure, place limitations on the activities, functions, or operations, suspend for a period not exceeding twelve months, or revoke the registration of any municipal advisor, if it finds that such municipal advisor has committed or omitted any act, or is subject to an order or finding, found in paragraphs (A), (D), (E), (H) or (G) of paragraph of section 15(b) of the Exchange Act; has been convicted of any offense specified Section 15(b)(4)(B) of the Exchange Act within ten years of the commencement of the proceedings under section 15(c)(4); or is enjoined from any action, conduct, or practice specified in Section 15(b)(4)(C) of the Exchange Act. The municipal advisor should promptly amend Sections 1 or 3 of Form MA-T if the information previously filed becomes inaccurate in any way and whenever a municipal advisor wishes to withdraw from registration. Item 2 called Municipal Advisory Activities lists eight advisory activities. Subpart Item 2 lists advice concerning the investment of the proceeds of municipal securities. Registered investment advisers are not required to register on MA-T if provide only this advisory service. Subpart Item 3 lists advice concerning guaranteed investment strategies. This relates to advice on bond proceeds deposited into guaranteed investment contracts (“GICs”). Subpart Item 4 lists recommendation of and/or brokerage of municipal escrow investments (registered investment advisers making only these recommendations are excluded from MA-T registration). Subpart Item 5 list advice concerning the use of municipal derivatives (e.g. swaps). If commodity trading advisor, then do not have to register on From MA-T. Item 3, called Disciplinary Information must be promptly amended if there are any changes. Dodd-Frank amended Section 15B(c)(2) of the Exchange Act and requires the SEC to censure; place limitations on the activities, functions, or operations; suspend for a period not exceeding twelve months; or revoke the registration of any person registered through Form MA-T, for the violations listed in Section 15(c)(4) of the Exchange Act pertaining to brokers or dealers.

In the September 1, 2010, release of the temporary rule, the SEC requested comments concerning whether to include persons whose disciplinary history is not sufficiently relevant to a municipal advisor’s activities to warrant disclosure. In addition, the SEC solicited specific suggestions as to how the disclosure regarding associated persons whose actions are covered by Item 3 of Form MA-T might be improved for purposes of a permanent registration program or whether the current limitation to associated municipal advisory professionals is suitable. As a result the SEC issued in December 2010, a proposal that received many comments. To date, this proposed rule has not been finalized.

The proposal clarified many of the definitions put forth in the temporary rule, and added to definition of municipal adviser, any attorney who engaged in municipal advisory activities. The term “natural person municipal adviser” was introduced to require employees of municipal advisers and sole proprietors to file Form MA-I. Proposed new Form MA would add to old Form MA-T, required reporting for municipal advisers succeeding other advisers. In addition, the number of advisory activities increased from eight to eleven. Form MA new Items would include reporting of: other business activities; participation or interest in municipal advisory client transactions; and advisory control persons. New Form MA-W and MA-NR was proposed for withdrawal of registration, and registration of non-U.S. residents, respectively. Finally, municipal advisers would be required to maintain book and records pursuant to federal regulations.

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CFTC Proposes Risk Management Guidelines for Swaps Clearing Members

December 19, 2011 James Hardaway Jr. Compliance, Hedge Funds, Private Equity, Proposed Regulations

In August 2011, the CFTC issued proposals to enhance risk management procedures
for clearing swaps. The intent of the proposed regulations is to facilitate customer
access to clearing and to enhance risk management at the clearing member level.
The CFTC believes that clearing members provide the portals through which market participants gain access to derivatives clearing organizations (“DCOs”) as well as the first line of risk management.

These proposals are consistent with the international standards established by the International Organization of Securities Commissions (“IOSCO”). The applicable IOSCO principles are: Principle 6, which states that: [a] market should not permit DEA [direct electronic access] unless there are in place effective systems and controls reasonably designed to enable the management of risk with regard to fair and orderly trading including, in particular, automated pre-trade controls that enable intermediaries to implement appropriate trading limits. Principle 7, which states that: [i]ntermediaries (including, as appropriate, clearing firms) should use controls, including automated pre-trade controls, which can limit or prevent a DEA Customer from placing an order that exceeds a relevant intermediary’s existing position or credit limits.

The proposals address risk management for cleared trades by FCMs, swap dealers (“SDs”), and major swap participants (“MSPs”) that are clearing members.

Proposed Section 1.73 of the Commodity Exchange Act would apply to clearing members that are FCMs; proposed Section 23.609 would apply to clearing members that are SDs or MSPs. These provisions would require clearing members to have procedures to limit the financial risks they incur as a result of clearing trades and liquid resources to meet the obligations that arise. Specifically, clearing members would be required to develop and implement procedures to: (1) establish credit and market risk-based limits based on position size, order size, margin requirements, or similar factors; (2) use automated means to screen orders for compliance with the risk-based limits; (3)monitor for adherence to the risk-based limits intra-day and overnight; (4) conduct stress tests of all positions in the proprietary account and all positions in any customer account that could pose material risk to the futures commission merchant at least once per week; (5) evaluate its ability to meet initial margin requirements at least once per week; (6) evaluate its ability to meet variation margin requirements in cash at least once per week; (7) evaluate its ability to liquidate the positions it clears in an orderly manner, and estimate the cost of the liquidation at least once per month; and (8) test all lines of credit at least once per quarter.

The CFTC observed these elements as sound risk management programs operating at DCOs and FCMs. However, they stated that these proposals do not prescribe the particular means of fulfilling these obligations. As with prior regulations for DCOs, clearing members will have flexibility in developing procedures that meet their needs. For example, items (1) and (2) could be addressed through simple numerical limits on order or position size or through more complex margin-based limits. Further examples could include price limits to reject orders that are too far away from the market, or limits on the number of orders that could be placed in a short time. Also, they listed some tools that could be used to monitor for risk and to mitigate and are important elements of a good risk management program: (i) the ability to see all working and filled orders for intraday risk management; (ii) a “kill button” that cancels all open orders for an account and disconnects electronic access, (iii) each clearing member should establish written procedures to comply with this regulation and to keep records documenting its compliance.

Comments were requested by September 30, 2011, on all aspects of the risk
management proposal. Specifically, (i) the extent to which each DCO already requires clearing member FCMs, SDs, and MSPs to have each component, and audits compliance with such requirement; (ii) the extent to which each component has otherwise been incorporated into existing risk management systems of clearing member FCMs, SDs, and MSPs; and (iii) the potential costs and benefits of each component.

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IRS Issues Proposal for Determining When a Foreign Government’s Investment Income is Exempt from U.S. Taxation

November 28, 2011 James Hardaway Jr. Compliance, Hedge Funds, Private Equity, Proposed Regulations, Tax

On November 2, 2011, the IRS proposed to supplement the June 1988 temporary regulations on guidance concerning the taxation of income of foreign and international organizations investing in the United States. The proposal was in response to
several comments on the 1988 rule.

According to section 892, a foreign government that derives income from both qualified investments and from commercial activity is eligible to claim tax exemption for only the income from qualified investments, but not the income from commercial activity.

The new proposal addresses government controlled entities (“GCE”) who are U.S. taxed for both its investment income and qualified investments income if they engaged in any commercial activities. The proposal provides a safe harbor, under certain conditions, for inadvertent commercial activities to not trigger taxation on GCE’s income from qualified investments.

The IRS also proposed, for both foreign governments and GCEs, income from investments in derivatives will be included with those investments that are not considered commercial activities. The current rule lists investments in physical stocks and securities as non-commercial activities. The IRS maintained the section 892 requirement that only income from investments in financial instruments held in the execution of governmental financial or monetary policy are tax exempt.

In addition, the IRS responded to comments requesting clarification as to whether an entity that disposes of a United States real property interest (USRPI), as defined in section 897, will be deemed to be engaged in commercial activities solely by reason of this disposition. The new proposal stated that a section 897 disposition is not a commercial activity. However, this disposition type would not be tax exempt.

Finally, the proposal modifies the general rule that income from commercial activities of partnerships are attributable to its general and limited partners. Section 892 provides an exception to income from commercial activities for publicly traded partnerships (“PTPs”). The proposal amended the PTP exception to include an entity who is not engaged in commercial activities will not be treated as engaged in commercial activities solely because it holds limited partnership interest in a limited partnership who has income from commercial activities. Similar to the above noted exceptions for commercial activities, the limited partner’s distributive share of partnership income attributable to commercial activities will not be tax exempt.

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CFA Institute: An Examination of Transparency in European Bond Markets

November 27, 2011 James Hardaway Jr. Compliance, Hedge Funds, Private Equity, Proposed Regulations

This brief made policy proposals to the European Union that are consistent with the recent proposals to the Markets in Financial Directive (“MiFID) to extend pre-trade and post trade transparency requirements to bond markets.

The European Commission in November 2007, issued the MiFID which “governs the provision of investment services in financial instruments (such as brokerage, advice, dealing, portfolio management, underwriting, etc.) by banks and investment firms and the operation of traditional stock exchanges and alternative trading venues ( so-called
multilateral trading facilities.” While MiFID created competition between these services and brought more choices and lower prices for investors, shortcomings were exposed in the wake of the 2008 financial crisis.

In October 2011, the European Commission proposed amendments to MiFID to regulate Organized Trading Facilities. These are markets where standardized derivatives contracts are traded. It also proposed a new trade transparency regime for non-equities markets (i.e. bonds and structured finance products).

The CFA noted that only Italy has extended pre-trade and post-trade transparency requirements to bonds. And the United States TRACE system has proved effective in decreasing the arbitrage situations that are caused when bond buyers and sellers meet away from an exchange. Investors in the European bond markets will benefit from enhanced transparency and decreases in trading costs, because the information advantages are eliminated as bond dealers will compete on prices, not assigned arbitrary indicative prices.

The CFA made the following recommendations to the European Union:

The information reported and the timeliness of the information should be based on the size of the trade relative to the size of the issue, and the level of recent trading in that issue.
Phase-in new requirements to help mitigate the risk of temporary negative impact on liquidity.
Investors should have access to post-trade data on reasonable commercial terms through approved publications.
Adopt a “wait and see” approach on pre-trade transparency because a single pre-trade requirement for OTC would be impractical.
Include the existing electronic trading platforms in implementing pre-trade transparency requirements for on-exchange transactions.

They noted that the European bond market has more than 150,000 debt securities, as
compared to 6,000 equity shares trading on regulated markets. And it is common for a company’s debt structure to include several layers of debt issues.

The European Commission’s proposals are to be reviewed by the European Parliament
and the Council (Member States) for negotiation and adoption. Once adopted the
Regulation, the Directive, and the necessary technical rules implementing these will apply together as of the same date.

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« Older Entries

Archive for Proposed Regulations

IOSCO Issues Policy Recommendations for Money Market Funds

CFTC Proposal to Harmonize Registration of Mutual Funds Already Registered with SEC

IOSCO Issues Proposal on Valuation of Assets and Shares of Collective Investment Schemes

FinCEN Releases Test Site for the New CTR and SAR

The OFR Directive to Implement Legal Entity Identifier for Financial Transactions

Qualified Advisers Must Register with the Municipal Securities Rulemaking Board

SEC Issues Extension for Registration of Municipal Advisers

CFTC Proposes Risk Management Guidelines for Swaps Clearing Members

IRS Issues Proposal for Determining When a Foreign Government’s Investment Income is Exempt from U.S. Taxation

CFA Institute: An Examination of Transparency in European Bond Markets

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