On Oct. 26, 2017, the U.S. Treasury Department (Treasury) released the latest installment in a series of reports on financial regulation required by the president's Feb. 3 executive order on the financial system. That order lists seven "core principles" underlying all Federal regulatory efforts in the financial sector — generally, (i) empowering American customers, (ii) preventing bailouts, (iii) fostering economic growth, (iv) enabling American competitiveness, (v) advancing American interests in international negotiations, (vi) making regulation efficient and (vii) restoring accountability.
The Oct. 26 report addresses asset management and insurance. Others in the series address banking (released June 12, 2017); capital markets (Oct. 6, 2017); and nonbank financial institutions, financial methodology and financial innovation (pending). A related executive order issued in April requires additional reports on the Orderly Liquidation Authority established by the Dodd-Frank Wall Street Reform and Consumer Protection Act, 111 P.L. 203 (Dodd-Frank), which is pending, and the process set forth in Dodd-Frank for identifying so-called systemically important financial institutions, or SIFIs, for regulation by the Federal Reserve Board of Governors (the Fed), which was released on Nov. 17, 2017.
Some of the notable observations and recommendations of the Oct. 26 report are as follows.
In Asset Management:
- Prudential regulation of asset management is unlikely
to be effective for mitigating systemic risk, if any,
arising from this sector. This is mainly due to the relatively low
level of leverage and liquidity management employed by the sector
as opposed to banking.
- While the Administration agrees in principle with the
historical practice of limiting a mutual fund's (e.g.,
a registered investment company, or RIC) illiquid holdings to 15
percent of net assets, implementation of the "highly
prescriptive" securities bucketing regime for
liquidity risk management adopted by the
Securities and Exchange Commission (the SEC) in 2016 should be
postponed.
- "Swing pricing" for redemptions by a
RIC (in which non-redeeming investors are protected from some of
the dilutive effects of redemptions) should be studied further. The
SEC's permission of swing pricing on a voluntary basis, set to
go into effect in November 2018, is noted by the report.
- The SEC is called on to develop new rules (or reactivate an
earlier proposal that stalled after 2008) to allow
exchange-traded funds (ETFs) easier access to the
capital markets by streamlining the process by which ETFs are
cleared by the SEC for issuance and trading. Currently ETFs must
obtain exemptive orders, on a case-by-case basis, from registration
requirements of the Investment Company Act of 1940.
- Rules of the Commodities and Futures Trading Commission (the
CFTC) should be amended to exempt a RIC and its adviser from
dual registration by the CFTC as a commodity pool
operator (a CPO).
- The CFTC and the SEC should work together in order to identify
a single regulator (the SEC or the CFTC) in cases where de facto
commodity pools operate without sufficient oversight.
- The report also calls for greater cooperation between the SEC
and the CFTC to share information, so that information filed by an
entity with one of these bodies might satisfy the informational
needs of the other body relating to the entity.
- The CFTC should exempt private funds and their advisers from
registration as a CPO if the adviser is "subject to regulatory
oversight by the SEC."
- Regulators and self-regulatory organizations should
"rationalize and harmonize" reporting regimes to minimize
reliance on redundant forms and submissions.
- The CFTC and the SEC should work together in order to identify
a single regulator (the SEC or the CFTC) in cases where de facto
commodity pools operate without sufficient oversight.
- Treasury supports the prospective adoption by the SEC of a
derivatives risk management program for RICs, but indicates a
preference for risk-adjusted measures rather than the notional
calculations under the rule proposed in 2015.
- The Report notes the Treasury's recommendations, set forth
in its Report on Banking, on relaxing some of the restrictions of
the Volcker Rule (Section 619 of Dodd-Frank and
the Federal agencies' final rule thereunder1). The
Volcker Rule generally imposes restrictions on the ability of banks
and non-bank SIFIs to engage in proprietary trading and to hold
"ownership interests" in certain types of private funds.
The report urges further efforts to "reduce the burden"
of the Volcker Rule on asset managers and investors, including
continued forbearance from enforcing
- the proprietary trading restrictions against foreign private
funds that are not "covered funds" under the Rule
and
- the restriction on funds' ability to share names with
banking entities.
- the proprietary trading restrictions against foreign private
funds that are not "covered funds" under the Rule
and
- Treasury also recommends amending Dodd-Frank to limit
stress testing requirements for investment
companies and investment advisers, either by eliminating all such
obligations or by deeming money market fund stress testing pursuant
to SEC Rule 2a-7 and liquidity risk management programs pursuant to
SEC Rule 22e-4 as satisfying Dodd-Frank mandates.
- In addition, the 2016 SEC proposal requiring registered
investment advisers to adopt written business continuity
plans should be withdrawn as overly costly and
onerous.
- In the area of international financial regulatory
negotiations, financial stability risk assessments should
be tailored to industry sectors. The United States should play a
leading role in international standard-setting bodies such as the
Financial Stability Board and the International Organization of
Securities Commissions and should work to improve the operations of
these bodies.
- The Report calls for delay in implementation of the
Fiduciary Rule.
- The rule, proposed in April 2016 by the Department of Labor
(the DOL) and effective in June 2017, subject to transition relief
recently extended from Jan. 1, 2018 to July 1, 2019, would
generally expand the scope of persons deemed to be
"fiduciaries" for purposes of the Employee Retirement
Income Security Act of 1974 (ERISA)) and Section 4975 of the
Internal Revenue Code. This would have the effect of, among other
things, prohibiting commission-based compensation from being used
when providing financial advice to owners of individual retirement
accounts, or IRAs, unless the adviser observes certain impartiality
covenants pursuant to the so-called "best interest contract
exception."
- Citing the risk that financial professionals might adopt
different practices for accounts that "are nearly
identical," the report warns of "unintended
consequences" and harm to investors if the Fiduciary Rule in
its current form is put into full effect.
- The report also calls for the SEC, the DOL and the states to work together to implement a regulatory framework appropriately tailored to both preserve investor choice and protect retirement investors in an efficient and effective manner, and to analyze the effects of different standards of care on the availability of annuities in the retirement market.
- The rule, proposed in April 2016 by the Department of Labor
(the DOL) and effective in June 2017, subject to transition relief
recently extended from Jan. 1, 2018 to July 1, 2019, would
generally expand the scope of persons deemed to be
"fiduciaries" for purposes of the Employee Retirement
Income Security Act of 1974 (ERISA)) and Section 4975 of the
Internal Revenue Code. This would have the effect of, among other
things, prohibiting commission-based compensation from being used
when providing financial advice to owners of individual retirement
accounts, or IRAs, unless the adviser observes certain impartiality
covenants pursuant to the so-called "best interest contract
exception."
In Insurance:
- States generally should continue as the prime engines
of insurance law and regulation, with the Federal
Insurance Office (the FIO) and other federal bodies consulting with
the states regularly on insurance matters being addressed at the
Federal level. This should mitigate the risk of duplicative
mandates.
- As with asset management, entity-based systemic risk
assessments are not the best approach for mitigating
sector-wide risks. The United State should support the
International Association of Insurance Supervisors (the IAIS) in
its focus on an activities-based approach and should take steps to
improve the IAIS's methodology for identifying global
systemically important insurers, or G-SIIs.
- The group capital standards being developed
and implemented by the National Association of Insurance
Commissioners (the NAIC), the states and the Fed should be
harmonized to avoid unnecessary redundancy.
- The FIO's mission should be confined to
five "pillars" — (i) promoting the U.S. state-based
regulatory system in international discussions, (ii) providing
insurance expertise to the U.S. government, (iii) providing
leadership and cooperation between the federal government and state
regulators, (iv) protecting the financial system by advising
Treasury and the Financial Stability Oversight Council on
insurance-related matters that may pose threats and (v) promoting
insurance products and administering the Terrorist Risk Insurance
Program.
- The FIO should be more transparent and should engage more
regularly with state regulators.
- The Fed is called on to leverage information received
by state insurance regulators and the NAIC on savings and
loan holding companies that are insurance companies, in order to
avoid duplicative regulatory efforts.
- The report calls on Congress to clarify what is included in the
"business of insurance" for purposes of
Dodd-Frank's grant of authority to the Consumer Financial
Protection Bureau, which is proscribed from regulating insurance
matters.
- The Department of Housing and Urban Development should
reconsider its "disparate impact" rule,
pursuant to which housing practices may be deemed discriminatory as
to a protected class, regardless of intent, if the practices
unevenly affect access to housing. The report explains that
disparate impact could adversely affect availability of
homeowner's coverage and may be inconsistent with state, rather
than federal, primacy in the regulation of insurance.
- On data security and cyber risks, Treasury endorses the
NAIC's model law on Insurance Data Security
(formally adopted by the NAIC mere days before the report was
released) and calls on states to adopt it promptly. If uniform
state laws for insurance company data security are not in place in
five years, Congress should adopt legislation, but this should be
administered by the states.
- States that have not entered the Interstate Insurance
Product Regulation Compact should do so in order to
further the use of uniform standards in regulating life insurance
products.
- States should adopt the NAIC's Producer Licensing
Model Act and should generally try to ease compliance
burdens imposed on insurance agents and brokers.
- Internationally:
- The report calls for the IAIS to postpone the next version of
its capital standard for internationally active insurance
groups, or IAIGs, beyond its anticipated 2019 completion
date in order to accommodate further discussion and
refinement.
- The IAIS should take additional steps to increase
transparency and collaboration with all of the
IAIS's stakeholders (such as U.S., NAIC and state
officials).
- The FIO should coordinate the efforts of the federal
government, state insurance regulators and the NAIC to
speak with one voice at the IAIS and advance American
interests.
- The report notes approvingly the September 2017 completion of
the Covered Agreement between the United States
and the European Union (the EU) providing for reciprocal treatment
in certain regulatory areas for insurers doing business across
those jurisdictions, as well as the administration's policy
statement issued in conjunction therewith, affirming the state
insurance regulatory system.
- The Treasury calls for exploring whether a
Covered Agreement between the U.S. and the U.K.
would be mutually beneficial "should the United Kingdom (U.K.)
withdraw from the EU."
- The report calls for the IAIS to postpone the next version of
its capital standard for internationally active insurance
groups, or IAIGs, beyond its anticipated 2019 completion
date in order to accommodate further discussion and
refinement.
- States should consider a more "calibrated" approach
to insurance company investments in
infrastructure, including revisions to risk-based
capital laws, to make these investments more attractive from a
regulated-capital perspective.
- The DOL and Treasury should pursue steps to encourage the
use of annuities in defined contribution retirement
plans covered by ERISA. The report cites ERISA compliance
as a reason for the decline in defined-benefit pensions in the
private sector.
- Treasury will convene an interagency task force among interested federal agencies to develop policies to "complement reforms at the state level" in the area of long-term care insurance. The task force is called on to collaborate with the NAIC on its efforts.
Footnote
1 12 CFR Parts 44, 248, and 351 17 CFR Part 255.
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