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Senate Approps FSGG Hearing on the CFTC and SEC Budget Requests

Senate Appropriations Subcommittee on Financial Services and General Government

“Review of the FY2020 Budget Request for the CFTC & SEC”

Wednesday, May 8, 2019

Key Takeaways

  • Consolidated Audit Trail (CAT): Chairman Kennedy noted some of the “promise” the CAT will provide due to compiling information on every securities trade but was cautious about whether the data will be secure. SEC Chairman Clayton replied that the CAT is needed for enforcement and surveillance issues as it will allow the agency to better understand market structure and any vulnerabilities that may exist. He explained that there will be two types of information collection, one being proprietary data of participants and the other being personally identifiable information of main street investors, noting that “both need to be addressed in any final CAT plan.”
  • Regulation Best Interest (Reg BI): Ranking Member Coons asked about the SEC’s proposed Reg BI. Clayton stressed the importance of preserving choice and competition in the marketplace for retail investor services. He explained that investors have a choice between a fee for service model and a fee per account model, which both have benefits depending on the needs of the individual investor, saying this is important for competition. Clayton said investors should “know who [they are] dealing with,” how they are getting paid, and what their incentives are, and it is important to raise the level of conduct required while preserving choice and competition.
  • Brexit: In response to a question from Coons on Brexit’s impact to the markets, CFTC Chairman Giancarlo noted that there could be a global impact if there is a “sudden” Brexit, but that if it is not sudden there is less concern about a short-term disruption in the markets. He continued that there is concern there is no continental European locale that can become the global servicing center for the derivatives market like London is, and that if London no longer remains the epicenter there could be a “real, strong impact on markets.” Giancarlo explained that conversations are happening with Brussels, London, and within the Financial Stability Oversight Council (FSOC) and that the situation is being monitored “closely.”

Witnesses

Opening Statements

Chairman John Kennedy (R-La.), FSGG Subcommittee

Kennedy waived his time for an opening statement, though thanked Giancarlo for his five years of hard work and public service, stating that “we’re just very, very grateful.”

Ranking Member Chris Coons (D-Del.), FSGG Subcommittee

In his opening statement, Coons also thanked Giancarlo and his family, and explained that he is interested in hearing from the two chairmen about how cryptocurrencies are challenging regulators, how cybersecurity remains a challenge for them, and how they have used their increased funding.

Testimony

The Honorable Jay Clayton, Chairman, SEC

In his testimony, Clayton noted that the SEC’s funding has enabled them to do targeted hiring in the following areas: cybersecurity enforcement, the examination program, market oversight, and small business capital formation. He continued that their funding level enabled the agency to lift their hiring freeze, invest in information technology, and continue executing their strategic plan. Clayton said that with their $1.746 billion request for FY2020, they will continue to focus on human capital, information technology, and leases for their headquarters and New York regional office.

The Honorable J. Christopher Giancarlo, Chairman, CFTC

In his testimony, Giancarlo discussed the “strong partnership” between the CFTC and SEC, noting that he and Clayton have been committed to working together on enforcing regulations, cryptocurrency, implementing Dodd-Frank, clearing, and disaster recovery. He continued that while the derivatives markets are not for capital formation or capital transfer, they are for risk mitigation and provide stable pricing for Americans. Giancarlo explained that the derivatives markets provide “deep pools” of trading liquidity and noted the participation of global counterparties, adding that the U.S. is the only country with an agency specific to regulating the derivatives market. He noted that they are requesting $315 million for FY2020, with most of it being for their annual operating funding and $31 million to relocate three of their offices.

Q&A

CAT

Kennedy noted some of the “promise” the CAT will provide due to compiling information on every securities trade but was cautious about whether the data will be secure. Clayton replied that the CAT is needed for enforcement and surveillance issues as it will allow the agency to better understand market structure and any vulnerabilities that may exist. He explained that there will be two types of information collection, one being proprietary data of participants and the other being personally identifiable information of main street investors, noting that “both need to be addressed in any final CAT plan.” Clayton stressed that social security numbers are no longer being collected and that they will be limiting the number of fields containing personal information, adding that they will not be collecting information unless it is needed.

Reg BI

Coons asked about the SEC’s proposed Reg BI. Clayton stressed the importance of preserving choice and competition in the marketplace for retail investor services. He explained that investors have a choice between a fee for service model and a fee per account model, which both have benefits depending on the needs of the individual investor, saying this is important for competition. Clayton said investors should “know who [they are] dealing with,” how they are getting paid, and what their incentives are, and it is important to raise the level of conduct required while preserving choice and competition.

Swaps Reform

Kennedy asked about swaps reform, to which Giancarlo replied that he was a supporter of the core reforms that became Title VII of the Dodd Frank Act, saying that moving swaps to clearing was already starting to increase in the marketplace as clearing provides “superior risk management, mutualization, and diversification.” He said that in terms of the swaps execution position, Dodd Frank got it right but the CFTC erred in its execution. He called these errors “natural,” but added that they made the market less competitive globally and has prevented new entrants and innovation. Giancarlo noted that he wants to propose a more flexible approach that will allow for more innovation and competition.

Brexit

In response to a question from Coons on Brexit’s impact to the markets, Giancarlo noted that there could be a global impact if there is a “sudden” Brexit, but that if it is not sudden there is less concern about a short-term disruption in the markets. He continued that there is concern there is no continental European locale that can become the global servicing center for the derivatives market like London is, and that if London no longer remains the epicenter there could be a “real, strong impact on markets.” Giancarlo explained that conversations are happening with Brussels, London, and within the Financial Stability Oversight Council (FSOC) and that the situation is being monitored “closely.”

Leveraged Lending

Clayton explained that the prudential regulators have met to discuss this topic and that the SEC is looking into whether leveraged lending has created new risk, adding that the Commission has been analyzing it “for a while,” sharing information in and out of the U.S. He continued that while it should be looked at, it does not keep him up at night “right now.” Giancarlo added that the CFTC is conducting a project to look at how leveraged loans are being used to mitigate exposure to the market and that he will make the study public when it is finished.

Arbitration

Sen. Chris Van Hollen (D-Md.) discussed a letter that 21 Senators sent to Clayton asking the SEC to continue allowing investors to “have their day in court” and not require arbitration. Clayton replied that he will do “everything [he] can” to ensure any proposal is analyzed, discussed, and decided “in an open way” with a public comment period, noting that the SEC “isn’t the only cook in the kitchen.”

Cryptocurrencies

Coons asked about cryptocurrencies, their risk, and how the CFTC budget request will utilize requested funds to expand exams into virtual currencies. Giancarlo said the requested amount will also apply to clearinghouses and other exchanges, not just virtual currency exchanges. He noted that for cryptocurrencies, the CFTC only has jurisdiction when there is fraud or manipulation, calling it a “buyer beware situation.” Clayton added that trades on foreign cryptocurrency exchanges could be fraudulent and there would be no way to know or do anything about it.

Current Expected Credit Loss (CECL)

Coons asked about the Financial Accounting Standards Board’s (FASB) newly issued accounting standard for current expected credit losses (CECL) and whether the SEC has conducted studies on its potential impact. Clayton said there has been a fair amount of debate, and while the SEC’s oversight of FASB does not include reviewing or approving rules, there are concerns about potential economic impacts. Clayton highlighted that the primary concerns include the cost of implementation, particularly for small and midsize banks, whether it will increase capital requirements, and the “dynamic effect” on the economy. Clayton said the SEC has encouraged the FASB to consider these concerns and take into account size considerations as the rule is implemented.

Disgorgement

Kennedy asked about disgorgement as a remedy for breaking securities laws and a proposed bill that would create a new authority for restitution. Clayton said that their current authority is limited to a five-year statute of limitations, explaining that in some cases, like Ponzi schemes or other well-concealed frauds, the statute of limitation impedes the SEC’s ability to get people their money back. Clayton said he would be supportive of such legislation.
Transaction Fees

In response to a question from Van Hollen on whether the CFTC is advocating for placing a small fee on some transactions to provide additional resources to the Commission, Giancarlo replied that it is up to Congress, and if they decide part of the budget should come from the marketplace, the CFTC will act on that.

EDGAR System Breach

Coons asked about the security of the EDGAR system. Clayton explained that the security of EDGAR has been lifted and the SEC has also reduced the amount of sensitive information in the system. Clayton said consultants have reviewed the work and have conducted penetration testing, and the SEC will continue to invest in and test the system going forward.

For additional information on this hearing, click here.