Blockchain as a Regulatory Solution: QFC Recordkeeping

The financial services industry has opened itself to technology as a solution.  FinTech, and now RegTech, dominate the conversation in what will shape the industry in years to come.  One of the most promising tools for those working at the intersection of finance and tech is blockchain.

In this whitepaper, which is the first in what will be an ongoing series by 8of9, explains the technology in an accessible way, and shows how implementing a distributed ledger can make required recordkeeping of qualified financial contracts cheaper, easier, and guarantee compliance.

This white paper was written by 8of9 CEO Mary Kopczynski and 8of9 consultants Brendan Roberts and Tyler Morris.

Blockchain as a Regulatory Solution


As We Predicted, Trump Attacks the Fiduciary Rule

Before he took office, 8of9 made predictions about the most likely deregulation actions President Trump would take, and it hasn't taken him long to begin to follow the script.  Within his first weeks in office, Trump has requested for the Department of Labor ("DoL") to review Obama's Fiduciary Rule, which is set to go into effect on April 10, 2017.  This request has caused the DoL to announce that it is "consider(ing) its legal options to delay the applicability date" as it complies with Trump's executive order.

8of9's earlier regulatory change chart, reflecting the DoL Fiduciary Rule change.

The Road Ahead

Analyzing what the administration has directly said about the regulation, there is a clear intent to not just delay implementation of the rule, but to never implement it.   Trump's press secretary Sean Spicer, commenting after Trump signed the executive order, said, "The rule is a solution in search of a problem.  There are better ways to protect investors, and the Trump administration is taking action to do so."  However, there are similarities between the fiduciary rule and Obamacare that may make total repeal of the rule difficult for Trump.  While deregulation in the abstract may have public support, reversing a rule aimed at protecting Americans' retirement accounts is a tough sell.

Adding to the administration's difficulty is a ruling out of the U.S. District Court for the Northern District of Texas on Wednesday, February 8.  The decision was in response to industry groups' attempts to stop the rule before enforcement.  In her 81 page decision, Chief Judge Barbara Lynn found the rule to be well-reasoned, in the best interest of consumers, and critically, that the rule did not overstep the Department of Labor's legal bounds.

"The court finds the DOL adequately weighed the monetary and non-monetary costs on the industry of complying with the rules, against the benefits to consumers," Lynn wrote.

"In doing so, the DOL conducted a reasonable cost-benefit analysis."

While the decision itself cannot change the administration's delay of implementation, it does uphold the legality of the rule, and outlines the reasons for which the rule was written.

The bottom line: 8of9 predicted that this was the most likely first fight for deregulation the Trump administration would wage, and we were right.  How this plays out remains to be seen, and the financial services industry will have to wait with bated breath to see if the rule will ever be enacted.


Exploring 8of9's RegTech: Introduction to Business Logic

8of9 became a RegTech firm in April 2016.  Since then, we’ve developed and continue to deliver innovative tech solutions that automate compliance with complex and shifting regulations. Our solutions allow clients to shift their existing business model into one that is predictive of regulatory needs, reducing the cost of compliance.

Check out our solutions for  the Net Stable Funding Ratio Rule and QFC Recordkeeping Rule! In this post we highlight the foundational tool in our RegTech solutions.

 

Business Logic

8of9 is the regulatory partner for Sapiens, a leading global technology company in the financial services industry. Our RegTech solutions use Sapiens DECISION™, a business decision management tool, to create a logic flow model for compliance with the latest financial regulations. .

8of9’s RegTech Experts:

  • Analyze lengthy regulations
  • Use their banking, technology, and legal expertise to extract critical information at their most granular
  • Ensure that each regulatory requirement is captured and represented within our model to produce outputs that meet our client needs

Our solutions are firmly based on the subject matter expertise and financial services experience of 8of9.

Qualified Index Test of 871(m) Solution

IRS Rule 871(m) is set to take effect on January 1, 2018, making life difficult for broker-dealers with  non-delta one contracts.

The Rule:  Imposes a withholding tax on derivatives that economically mirror a direct investment in a US equity, which itself would require a withholding tax.  This seeks to addressan increase in use of foreign derivatives which fall outside traditional withholding requirements, leading to diminished revenues for the IRS.  One of the exceptions carved out in the 2018 version of871(m) is for qualified indexes.  The rule contains a description of a qualified index, and allows those affected by the rule to determine whether their derivatives are based on such an index.

For broker-dealer clients, attempting to respond to 871(m) would be difficult, as there is no set list of qualified indexes.  Adding to the complexity, the language of the rule allows a formerly qualified index to become unqualified if certain metrics shift.  This can leave a broker-dealer exposed to running afoul of the IRS.

With 8of9’s 871(m) Qualified Index Solution, broker-dealers  access a model mapping out all aspects of the qualified index test and plug their own data streams directly into the tool.

 

Department of Labor Fiduciary Rule Solution

One of 8of9’s most requested RegTech solutions is for the anticipated Department of Labor’s (DoL) Fiduciary Rule.

The Rule: While this regulation’s future is currently uncertain (read more about 8of9’s views of the regulatory landscape under Trump), investment advisers who are under its purview must prepare for it.

The DoL Fiduciary Rule Solution outlines every investment relationship which triggers the Fiduciary Rule and creates independent fact types for each relationship.  8of9 maps the relevant data pointsso that advisers have a clear view of their current responsibility under the Fiduciary Rule.

8of9 is an agile, adaptable RegTech firm made up of experts who can create the customized tools to address your regulatory needs. The 871(m) and Fiduciary Rule solutions are two tools that were highly requested by clients and are currently in development.  If your financial institution, brokerage, or team of advisers has a regulatory need, contact us and your request may become our team’s next project.


Trump, the Volcker Rule, and Glass-Steagall

With Republican victory in 2016, and the Trump transition teams’ vow to “dismantle” Dodd-Frank, one regulatory provision that is in Republican crosshairs is the Volcker Rule.  However, targeting the Volcker Rule does not square with the Republican campaign promise to create a new Glass-Steagall.

The history of the rule

Republicans have been opposing the Volcker Rule since its inception[1]. With Trump in office, and Republican control of the Senate and Congress, the rule’s demise seems all but certain. Still, with a return of Glass-Steagall in the Republican 2016 platform, things may not be so simple.[2]

 

The Volcker Rule was enacted as part of the Dodd-Frank reforms of 2010. It was passed with the purpose of reducing conflicts of interest and ensuring bank stability by limiting activities which could cause undue risk or loss.[3] It limits the ability of U.S. depository institutions from engaging in proprietary trading, or having any ownership interest in a hedge fund or private equity fund.[4]  For the purposes of this rule, proprietary trading means engaging as a principal for the trading account of the relevant entity in any transaction to purchase or sell, or otherwise acquire or dispose of, various financial instruments.[5]

 

Glass-Steagall was a financial regulatory law passed in 1933 in the fall out of the Great Depression. Its core provision separated commercial banking from investment banking. The purpose was to prevent bank runs and cut down on speculative trading.[6] Glass-Steagall was repealed over time, having its provisions cut back between the 70s and the 90s, until its final repeal with passage of the Gram-Leach-Bliley Act in 1999.[7] While most analysts agree that the repeal of Glass-Steagall did not cause the 2008 recession on its own, many believe that it played some role in exacerbating it.[8]

 

To many, a new form of Glass-Steagall seems like a more burdensome way of accomplishing several of the same protections that Volcker already has in place. For that reason, many analysts believe that calls for a new Glass-Steagall are more political posturing than a call for new legislation, and that Republicans will instead focus efforts in lessening the controls under the Volcker Rule.

glass-st-1

Why the Pivot?

Many analysts believe that Trump’s calls for a new Glass-Steagall were more politics than policy. They argue that Trump used the introduction of a new Glass-Steagall as a ploy to distinguish himself from both his fellow Republicans and Hillary Clinton. Throughout the presidential race Clinton was attacked for her purported close ties to Wall Street.[9] Analysts feel that, by espousing a belief in a new Glass-Steagall, Trump was signaling that he was determined to truly take a hard line against banks.

 

However, in reality, a new Glass-Steagall would be highly disruptive to the financial services industry. Among other things, it would cause a break up of several very large Banks including JPMorgan Chase & Co. and Citigroup. For a President, whose primary goal is revitalizing the economy, it is unlikely that he would introduce a law that would cause massive uncertainty and financial instability. It is even more unlikely that a primarily Republican Congress would pass such a law.

volck-1Republicans have had the Volcker Rule squarely in their sites for years. Jeb Hensarling’s Financial CHOICE Act calls for a complete repeal of the Volcker Rule.[10] Additionally, Trump’s pick for the new Treasury Secretary Steven Mnuchin is a strong opponent of the Rule.[11] Republicans dislike the Volcker Rule because they feel like it impedes upon legitimate activity and unnecessarily precludes certain types of transactions. Republicans argue that Volcker, as it stands, disrupts legitimate financial functions, such as intermittent market making activity, with its provisions.  They also feel that the Volcker Rule serves to decrease liquidity, and wipe out certain financial products altogether. Additionally, Republicans do not see proprietary trading as the actual cause of the financial recession.[12]

The Likelihood of Change

Despite the intentions of Trump’s administration, without a Republican supermajority in the Senate it would be difficult to pass a law repealing Volcker. Democrats in Congress will approach any attempts to change the Volcker Rule with a scorched earth filibuster. Similarly, the law mandates most of its regulatory requirements making it difficult to change the rules through administrative and executive fiat.

 

Still, Republicans will change some of the provisions of the Volcker Rule to loosen requirements. Moreover, Republicans will look to administrative methods of punching holes in the wall. Trump may also rely on a mixture of regulatory changes and enforcement changes to give banks more latitude and lessen the burdens of the Volcker Rule. For example, Republicans can slow down enforcement of the law, giving the financial services industry more leeway to enter the gray areas of the law without worrying about administrative repercussions.[13]

[1] https://www.ft.com/content/bd48b836-4cce-11df-9977-00144feab49a

[2] http://www.bloomberg.com/politics/articles/2016-07-18/republican-platform-under-trump-backs-glass-steagall-s-return

[3] Dombalagian, Onnig, The Expressive Synergies of the Volcker Rule, 54 B.C.L. Rev. 469 (2013),

http://lawdigitalcommons.bc.edu/bclr/vol54/iss2/3

[4] Dombalagian, (2013)

[5] Dombalagian, (2013)

[6] http://www.federalreservehistory.org/Events/DetailView/25

[7] http://cepr.net/documents/publications/dereg-timeline-2009-07.pdf

[8] http://www.huffingtonpost.com/dennis-m-kelleher/the-lessons-of-repealing-glass-steagall_b_8532666.html

[9] http://www.americanbanker.com/news/law-regulation/trump-is-unlikely-to-bring-back-glass-steagall-1092394-1.html

[10] http://financialservices.house.gov/uploadedfiles/financial_choice_act-_executive_summary.pdf

[11] http://www.wsj.com/articles/trump-treasury-choice-steven-mnuchin-vows-to-strip-back-dodd-frank-1480513188

[12] https://www.washingtonpost.com/news/wonk/wp/2013/12/10/there-are-six-main-arguments-against-the-volcker-rule-heres-why-theyre-wrong/?utm_term=.50cae662b2b4

[13] https://www.bloomberg.com/gadfly/articles/2016-11-11/goldman-s-slow-volcker-compliance-could-pay-off


QFC Recordkeeping: Like a Box of Chocolates

This October, the Financial Stability Oversight Council created a new recordkeeping and reporting rule for qualified financial contracts (“QFCs”).  This deck will explain what a QFC is, who is subject to the rule, and how to best prepare for compliance with the rule.

8of9 is a next generation RegTech company that translates complex financial regulation into simple solutions.  Our tools capture, store, and monitor regulatory content so you can focus on doing what you do best.

Presentation QFC Recordkeeping: Like a Box of Chocolates


Net Stable Funding Ratio: Fad Diets

Basel III introduced the Net Stable Funding Ratio (“NSFR”) to the financial market.  The regulation is a complicated formula, that aims to have banks fund their long-term assets through long-term sources, rather than risky short-term funding.

8of9 is a next generation RegTech company that translates complex financial regulation into simple solutions.  Our tools capture, store, and monitor regulatory content so you can focus on doing what you do best.

Presentation Net Stable Funding Ratio


Predicting Trump's Regulatory Changes

Nearly a decade after the 2008 financial crisis, Donald Trump and the Republican Congress will likely make substantial changes to financial services regulatory policy.

There’s no question that regulatory policy will shift but how will this affect current and future financial regulations?

8of9’s Regulatory Experts have some thoughts!

This infographic shows how we think critical regulatory initiatives will be affected.

trump-change-infographic
Click to Enlarge.

Dodd Frank in Trump’s America: The Financial CHOICE Act

The Financial CHOICE Act is a likely point of departure for regulatory reform of Dodd-Frank. The Trump Transition team has recently announced that they plan on “dismantling” Dodd-Frank.[1] A logical first place to look for a Republican blueprint for “dismantling” Dodd-Frank is the Financial CHOICE[2] Act (CHOICE Act).

The CHOICE Act aims to simplify the regulatory process by putting a premium on clarity. Below we’ve highlighted four key areas of the CHOICE Act that may allow it to work.

 

Dodd-Frank Off Ramp

The Dodd-Frank “Off-Ramp”

The CHOICE Act’s Off-Ramp Provisions will create a means of circumventing many of Dodd-Frank’s requirements, including the Basel III capital and liquidity standards, and the ‘heightened prudential standards’ under Dodd-Frank section 165. Effectively, the off-ramp provisions may allow a firm to avoid or limit their need for adherence to the Comprehensive Capital Analysis and Review(CCAR). To use the “off-ramp” financial institutions are required to maintain at least a 10% leverage ratio and a composite CAMELS rating of 1 or 2.

It is hard to determine exactly how much pushback on these provisions may be expected from Democratic lawmakers. In accordance with Basel III, the Federal Reserve only requires SIFIs to maintain a leverage ratio greater than 6%. The “off-ramp” would require a two-thirds increase in capital requirements. Democratic lawmakers, however, may reject the absence of a risk-weighted ratio to complement the leverage ratio, especially in the absence of other Dodd-Frank compliance requirements. Republicans will likely push back, questioning the efficacy and complexity of these requirements. It may be the case that several Senate Democrats will accept the principle of an “off-ramp,” instead focusing on how the “off-ramp” capital requirements will be calculated, and how much capital will be required to escape the Dodd-Frank requirements. In this case, Republicans may attempt to steer Democrats toward the least complex and least onerous changes.

choice-act-2

Bankruptcy Not Bailouts

These provisions will replace the Orderly Liquidation Authority (OLA) with a new title to bankruptcy code and will remove several “bail-out” powers. Among the changes will be limitations on the Feds emergency lending authority under Section 13(3) of the Federal Reserve Act.

While placing limitations on several “bail-out” powers may attract bipartisan support, the looming shadow of the Lehman bankruptcy will make a full repeal of the OLA an unsavory prospect. In the aftermath of the Financial Crisis of 2008, there has been an ongoing debate about the risk of moral hazard in using government funds to “bail-out” so called “too big to fail” financial institutions. While such moral hazard remains unpalatable to many lawmakers, the difficulties of unwinding a massive and complex financial institution through a more conventional bankruptcy procedure will make many Democratic lawmakers unwilling to change the law.

While a new chapter of the bankruptcy code may allow lawmakers to correct some of the problems found when unwinding Lehman brothers, Democratic lawmakers may prefer to keep the OLA process in place, in large part because the OLA FDIC receivership process allows for a “softer landing” for failing financial institutions. This likely will be one of the provisions that Republicans have an uphill climb in passing.

choice-act-3

Reform of the Consumer Financial Protection Bureau (CFPB)

These provisions weaken the CFPB but do not remove it. They reform the CFPB in several ways including replacing the Bureau’s sole Director with a multi-member, bipartisan commission, giving courts more power to overturn CFPB rulings, requiring cost benefit analysis for new CFPB regulations, and providing for congressional veto of those new regulations.

It is unclear exactly how controversial these provisions will be to Democratic lawmakers. Democratic lawmakers will cite the CFPB’s successes in helping to protect consumers from financial fraud and manipulation as grounds for not putting checks on its power. However, some Democratic lawmakers may be convinced to accept controls on the CFPB’s administrative power.

choice-act-4

 

Federal Reserve Living Will and Stress Test Reform

These provisions keep the Living Will and Stress Tests of Dodd Frank, but will make living wills a bi-yearly requirement and put the onus on the regulators to create a more clear and transparent process for stress testing. Organizations that currently submit living wills will continue to submit living wills. However, living wills will only be required once every two years and regulators will be required to provide feedback within six months of submission. Additionally, regulators will be required to publicly disclose their assessment frameworks. Moreover, regulators will be required to clarify stress testing requirements and publish a summary of all stress test results.

Whether or not Democratic Lawmakers pushback on these provisions may be irrelevant.  If bipartisan support cannot be found to pass these provisions legislatively, many of these changes may be enacted through regulatory change. Dodd-Frank Section 165 does not prohibit these changes.

[1] https://www.greatagain.gov/policy/financial-services.html

[2] “Creating Hope and Opportunity for Investors, Consumers and Entrepreneurs.”


Dodd-Frank In Trump's America

Just eight years after the financial crisis of 2008, Donald Trump and the Republican Congress’ victory in the 2016 election likely marks a substantial change in financial services regulatory policy, especially with regards to Dodd-Frank. This article will serve as the first in a multi-part series covering the Trump administration’s likely impact on the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank).

repeal-bill

The Trump Administration Vows to “Dismantle” Dodd-Frank

The Trump Transition Team has highlighted “dismantling” Dodd-Frank as one of its top priorities, arguing that the Dodd-Frank economy is ineffective because of bureaucratic red tape, and that Washington’s regulatory mandates are not the answer. The President-Elect’s Financial Services Policy Implementation team plans to work towards “dismantling” the Dodd-Frank Act and replacing it with new policies that they feel will encourage economic growth and job creation.

There has been considerable backlash to “dismantling” Dodd-Frank, especially from Democratic lawmakers. Various members of the Senate, including soon to be Senate Minority Leader Chuck Schumer[1] and Senator Elizabeth Warren,[2] have expressed vehement opposition to changes to Dodd-Frank due to concerns that deregulation could risk instability in the financial system, and the economy.[3] Meanwhile, Federal Reserve Chairwoman Janet Yellen[4] and the eponymous former Congressman Barney Frank,[5] have warned against a hasty and universal repeal of the law due to fears that the absence of Dodd-Frank’s protections would return the financial services industry to the conditions that preceded the 2008 recession.[6]

dodd-frank

Room for Collaboration

Despite opposition to changing Dodd-Frank, some Democrats may be willing to collaborate with Republican lawmakers on potential reforms. Senate Democrats like Sherrod Brown and Jon Tester have already voiced some willingness to work with House Republicans on changing Dodd-Frank. Even former Congressman Barney Frank has alluded to some flaws in the law that could potentially be changed.[7] However, with only 51 or 52 seats in the Senate, Republicans will have a difficult time securing the required 60 votes to cloture a potential Democratic filibuster, without taking substantial steps to reach across the aisle. Moreover, Senator Chuck Schumer is confident that he will be able to prevent a total repeal of the law stating that he has “60 votes to block [President Elect Trump.]”[8] This means that a total repeal of the law is unlikely and that President Elect Trump may have difficulty winning over Senators in his own party when attempting to change Dodd-Frank.

Moving Forward with Deregulation

Changing Dodd-Frank will certainly be a contentious process, but there are avenues available for Republicans to change the law and associated regulations irrespective of Democratic opposition. Hence, despite early rhetoric from both sides over the issue, the question is not whether Dodd-Frank will be altered — the question is in what ways will it be altered.

8of9 will continue to explore several core issues related to modifying the current Dodd-Frank regulatory landscape. Next week we will discuss the Financial CHOICE Act and its implications on legislative change.


Footnotes:

[1] http://www.cnbc.com/2016/11/21/repeal-dodd-frank-it-wont-be-easy-for-donald-trump-to-end-the-rule.html

[2] http://www.bloomberg.com/news/articles/2016-11-20/schumer-says-he-ll-fight-trump-tooth-and-nail-over-dodd-frank

[3] http://www.marketwatch.com/story/elizabeth-warren-says-shell-fight-trump-over-dismantling-dodd-frank-2016-11-10

[4] http://www.thefiscaltimes.com/2016/11/17/Yellen-Sends-Message-Trump-Hands-Dodd-Frank

[5] http://www.pressherald.com/2016/11/20/barney-frank-others-caution-about-hasty-repeal-of-dodd-frank/

[6] http://www.bostonmagazine.com/news/blog/2016/11/28/barney-frank-donald-trump-recession/

[7] http://www.bloomberg.com/news/articles/2016-11-20/schumer-says-he-ll-fight-trump-tooth-and-nail-over-dodd-frank

[8] http://www.politico.com/story/2016/11/elizabeth-warren-trump-transition-231412


How Credit Default Swaps Could Change the World

Mary K analyzes how credit default swaps can be used to improve philanthropy and impact investing.