SEC ADOPTS RULE DEFINING TERMS RELATING TO OVER-THE-COUNTER SWAPS MARKET

FROM:  SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., April 18, 2012 – The Securities and Exchange Commission today unanimously adopted a new rule to define a series of terms related to the over-the-counter swaps market.

The rules, written jointly with the Commodity Futures Trading Commission (CFTC), implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that established a comprehensive framework for regulating derivatives.

“Adopting these entity definitions is a foundational step in the establishment of the new regime to regulate trading in this significant market,” said SEC Chairman Mary L. Schapiro. “These rules clarify for market participants whether their current activities will subject them to comprehensive oversight in the coming months.”

The final rule will become effective 60 days after the date of publication in the Federal Register.

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FACT SHEET

 

Defining Swaps-Related Terms

 

Background

In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which established a comprehensive framework for regulating the over-the-counter swaps markets. Under the Dodd-Frank Act, regulatory authority over swaps is divided between the SEC and the Commodity Futures Trading Commission (CFTC).

The law assigns the SEC the authority to regulate “security-based swaps,” which are broadly defined as swaps based on (1) a single security or (2) a loan or (3) a narrow-based group or index of securities or (4) events relating to a single issuer or issuers of securities in a narrow-based security index. The CFTC, on the other hand, has primary regulatory authority over swaps.

It is anticipated that the vast majority of the security-based swaps that would fall under SEC jurisdiction would be single-name credit default swaps (CDS). A CDS is a financial agreement in which the seller pays the buyer a sum of money if a default should occur. In the case of a single-name CDS, the underlying item or reference upon which the CDS is based could be a single company, a single government, or a single borrower. If that company, government, or borrower defaults, the CDS buyer would receive a payout.

Title VII of the Act authorizes the SEC to regulate security-based swap dealers and major security-based swap participants, and create a system by which they could register with the SEC. Those dealers and major participants also would be subject to several statutory requirements including requirements related to capital, margin, and business conduct.

Title VII of the Act, which defines the relevant terms, directs the SEC and the CFTC jointly to further define those terms in consultation with the Board of Governors of the Federal Reserve System. Those terms include “swap dealer,” “security-based swap dealer,” “major swap participant,” “major security-based swap participant,” and “eligible contract participant.” In December 2010, the SEC and CFTC proposed joint definitions of those terms.

If adopted, the joint rules would establish which entities involved in the swaps market would be subject to the regulatory regime created by the Dodd-Frank Act.

The Final Rules

The joint rules of the SEC and the CFTC define the terms “security-based swap dealer” and “major security-based swap participant” as part of the Securities Exchange Act of 1934.

In developing these definitions, the SEC staff was informed by existing information regarding the single-name CDS market, which will constitute the vast majority of security-based swaps.

The staff also relied on the dealer-trader distinction, which informs determinations regarding dealer status in the traditional securities market and which already is used by participants in that market.

Definition of “Security-Based Swap Dealer”

The new Rule 3a71-1 under the Securities Exchange Act defines the term “security-based swap dealer” consistent with the criteria set forth in the Dodd-Frank Act as someone who:

• Holds themselves out as a dealer in security-based swaps.
• Makes a market in security-based swaps.
• Regularly enters into security-based swaps with counterparties as an ordinary course of business for their own account.
• Engages in activity causing them to be commonly known in the trade as a dealer or market maker in security-based swaps.

Consistent with the statute, the new rule also specifies that the term “security-based swap dealer” does not include a person who enters into security-based swaps for their own account “not as a part of a regular business.”

The new rule interprets this definition in a manner that builds on the dealer-trader distinction that already is used to identify dealing activity involving other types of securities, while taking into account the special attributes of security-based swap markets. Further, the SEC would clarify the distinction between dealing activity and non-dealing activity such as hedging.

In addition, the new rule excludes from the dealer analysis (as well as the major participant analysis) security-based swaps between counterparties that are majority-owned affiliates.

De minimis exception: The Dodd-Frank Act directs the SEC to implement a de minimis exception from the “security-based swap dealer” definition for a person who “engages in a de minimis quantity of security-based swap dealing….” It also directs the SEC to establish factors for determining when someone falls within this exception.

The new Exchange Act rule 3a71-2 implements the exception in a way that is tailored to reflect the different types of security-based swaps and to phase in compliance in a way that would promote the orderly implementation of Title VII.

For instance, the new rule exempts those entities or individuals who engage in dealing activity in security-based swaps above a certain notional dollar amount over a prior one-year period:

• For credit default swaps that are security-based swaps, the de minimis exception in general is available to persons who enter into up to $3 billion in notional CDS dealing transactions over the prior 12 months.
• For other types of security-based swaps, this threshold is $150 million, reflecting the proportionately smaller size of this part of the market.

The proposed rule had set forth an across-the-board $100 million notional threshold.

In addition, the new rule:

• Sets a different de minimis exception for security-based swaps with “special entities” (as defined in Exchange Act Section 15F(h)(2)(C) to include certain governmental and other entities). For those special entities, the threshold is $25 million in notional amount over the prior 12 months. This is consistent with the proposed rule.
• Neither limits the number of security-based swaps that a person can enter, nor limits the number of a person’s security-based swap counterparties in a dealing capacity. This is in contrast to the proposal.

Phase in: The new de minimis rule will be phased in over time depending on the level of security-based swap dealing activity in a way that promotes the orderly implementation of Title VII.

• For credit default swaps, only those entities and individuals who transact $8 billion or more worth of CDS dealing transactions over the prior 12 months initially have to register as security-based swap dealers.
• For other types of security-based swaps, the phase-in level is $400 million.

These phase-in levels will terminate at a future date after SEC staff completes a report on the security-based swap market – unless the SEC establishes new de minimis thresholds or, absent that, after a period of time specified in the rule.

The SEC’s de minimis thresholds were tailored to the specifics of the products and the markets based on analysis of available data. In particular, this analysis highlighted the significant concentration in the single-name CDS market, which is the portion of the CDS market regulated by the SEC. Both the $3 billion de minimis threshold and the $8 billion phase-in level for CDSs should ensure that the vast majority of notional dealing activity in this market is subjected to the SEC’s Title VII dealer regulatory regime, consistent with the statutory de minimis exception.

Similarly, for security-based swaps other than CDSs, the effort was guided in part by data that showed that the size of this market is only a small fraction of the size of the CDS market. Consistent with this difference between these two markets, the new rule sets the de minimis threshold for these security-based swaps at $150 million and the phase-in level at $400 million.

In establishing who is a security-based swap dealer, Congress gave the SEC the task of identifying those entities that specifically engage in dealing activity in this market. In doing so, Congress did not intend for all or even most market participants who merely engage in security-based swap transactions – such as mutual funds and pension funds – to be regulated as security-based swap dealers. Further, in addition to limiting the pool to just dealers, Congress also sought to have the SEC regulate only those market participants who engage in dealing activity above a de minimis amount. By following Congress’s mandate to capture those engaged in dealing activity (even above a certain threshold), the new rule extends the protections of the Title VII dealer regulatory regime not only to regulated dealers but also to their counterparties.

Definition of “Major Security-Based Swap Participant”

The term “major security-based swap participant” is defined by rules 3a67-1 through 3a67-9 of the Securities Exchange Act.

In particular, the Dodd-Frank Act lays out three parts to the definition, and a person who satisfies any one of them is a major security-based swap participant:

• A person who maintains a “substantial position” in any of the major security-based swap categories, excluding positions held for hedging or mitigating commercial risk and positions maintained by certain employee benefit plans for hedging or mitigating risks in the operation of the plan.
• A person whose outstanding security-based swaps create “substantial counterparty exposure that could have serious adverse effects on the financial stability of the U.S. banking system or financial markets.”
• Any “financial entity” that is “highly leveraged relative to the amount of capital such entity holds and that is not subject to capital requirements established by an appropriate federal banking agency” and that maintains a “substantial position” in any of the major security-based swap categories.

The statutory definition excludes security-based swap dealers.

Definition of “Substantial Position”

The Dodd-Frank Act provides that the SEC should define “substantial position” at a threshold it deems to be “prudent for the effective monitoring, management or oversight of entities that are systemically important or can significantly impact the financial system of the United States.”

Under the new rule, “substantial position” is defined by using objective numerical criteria which promote the predictable application and enforcement of the requirements governing major participants. The new rule utilizes tests that would account for both current uncollateralized exposure and potential future exposure. A position that satisfies either test is a “substantial position.” The first “substantial position” test excludes positions hedging commercial risk and employee benefit plan positions from the substantial position analysis.

These tests apply to a person’s security-based swap positions in each of two major security-based swap categories: security-based credit derivatives (any security-based swap based on instruments of indebtedness including loans or on credit events relating to one or more issuers or securities) and other security-based swaps.

First Test of “Substantial Position”

The first substantial position test under the new rules:

• Measures a person’s current uncollateralized exposure by marking the security-based swap positions to market using industry standard practices.
• Allows the deduction of the value of collateral that is posted with respect to the security-based swap positions.
• Calculates exposure on a net basis, according to the terms of any master netting agreement that applies.

The thresholds established under the new rule for the first test are a daily average current uncollateralized exposure of $1 billion in the applicable major category of security-based swaps.

Second Test of “Substantial Position”

The second test under the new rule accounts for both current uncollateralized exposure and the potential future exposure associated with a person’s security-based swap positions. The second substantial position test determines potential future exposure by:

• Multiplying the total notional principal amount of the person’s security-based swap positions by specified risk factor percentages (ranging from 6 to 15 percent) based on the type of swap and the duration of the position.
• Discounting the amount of positions subject to master netting agreements by a factor ranging between zero and 60 percent, depending on the effects of the agreement.
• Further discounting the amount of the positions by 90 percent if the security-based swaps are cleared, or by 80 percent if they are subject to daily mark-to-market margining.
• The thresholds established under the new rule for the second test are $2 billion in daily average current uncollateralized exposure plus potential future exposure in the applicable major security-based swap category.

Definition of “Hedging or Mitigating Commercial Risk”

As noted, the first test of the major participant definition excludes positions held for “hedging or mitigating commercial risk” from the substantial position analysis.

The definition in the new rule for “hedging or mitigating commercial risk” encompasses any security-based swap position that is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise, where the risks arise in the ordinary course of business from a potential change in the value of:

• Assets that a person owns, produces, manufactures, processes, or merchandises.
• Liabilities that a person incurs.
• Services that a person provides or purchases.

The definition of hedging or mitigating commercial risk does not encompass any security-based swap position that is held for a purpose that is in the nature of speculation or trading. Also, in contrast to the proposed rule, the new rule does not include requirements for assessing the effectiveness of hedging positions or for documenting that assessment.

Definition of “Substantial Counterparty Exposure”

The new rule defines substantial counterparty exposure using a calculation method that is the same as the method used to calculate substantial position. However, the definition of substantial counterparty exposure is not limited to the major categories of security-based swaps, and does not exclude hedging or employee benefit plan positions. Rather it encompasses all of a person’s security-based swap positions.

The thresholds established under the new rule for substantial counterparty exposure are a current uncollateralized exposure of $2 billion or a sum of current uncollateralized exposure and potential future exposure of $4 billion across the entirety of a person’s security-based swap positions.

Definition of “Financial Entity” and “Highly Leveraged”

The third aspect of the statutory definition of major security-based swap participant addresses any “financial entity” – other than one subject to capital requirements established by an appropriate federal banking agency – that is “highly leveraged” relative to the amount of capital it holds, and that maintains a substantial position in a major category of security-based swaps. For this part of the definition, the new rule uses the same definition of substantial position described above without excluding hedging or employee benefit plan positions.

For this aspect of the definition, the new rule uses the definition of “financial entity” that is based on the definition of that term in the Dodd-Frank Act provision for an end-user exception from mandatory clearing in Exchange Act Section 3C(g)(3). The new rule defines the term “highly leveraged” as reflecting a ratio of liabilities to equity in excess of 12-to-1. The proposal had set forth 8-to-1 and 15-to-1 as alternative thresholds.

Additional Aspects of the Definition of Major Security-Based Swap Participant

The new rule contains the following changes from the proposal:

• Includes a safe harbor that provides that a person is not be deemed to be a major participant under certain conditions. Those conditions account for, among other things: the notional amount of the person’s security-based swap positions, the maximum possible uncollateralized exposure associated with the person’s security-based swap positions, and monthly calculations of current exposure and potential future exposure. The safe harbor is intended to help persons who are not likely to be major participants avoid the costs of performing the full major participant calculations.
• The rulemaking further clarifies that security-based swap positions are attributed to beneficial owners of an account, or to parents or affiliates of a person, only when the counterparty to a security-based swap has recourse to the beneficial owner, parent or affiliate.
• The new rule makes additional changes to the major participant tests, many of a technical or clarifying nature.

Report: Under the new rule, the SEC staff has to report to the Commission on whether changes should be made to the rules defining both security-based swap dealers and major security-based swap participants (including the rule implementing the de minimis exception to the dealer definition).

The staff must complete this report no later than three years following the later of:

• The last compliance date for the registration and regulatory requirements for security-based swap dealers and major security-based swap participants.
• The first date on which compliance with the trade-by-trade reporting rules for credit-related and equity-related security-based swaps to a registered security-based swap data repository is required.

Commodity Exchange Act Amendments: In addition to updating the Securities Exchange Act, the new rules jointly written by the SEC and the CFTC further define “swap dealer” and “major swap participant” in the Commodity Exchange Act (CEA). These rules and interpretations in many respects are parallel to the Exchange Act rules and interpretations addressed above.

The new rule also further defines “eligible contract participant” under the CEA. The term “eligible contract participant” also is used in the Securities Exchange Act and is defined by cross reference to the CEA.

What’s Next?

These new rule becomes effective 60 days after the date of publication in the Federal Register. However, dealers and major participants will not have to register with the SEC until the dates that will be provided in the SEC’s final rules for the registration of dealers and major participants.

When the new rule further defining “eligible contract participant” becomes effective, certain exemptive relief that the SEC provided in connection with section 6(l) of the Exchange Act will expire. At that time, dealers, major participants, and other persons will become subject to section 6(l), which prohibits any person from effecting a security-based swap transaction (other than on a national securities exchange) with a person who is not an eligible contract participant, under the definition as amended by Title VII and as further defined by the new rule.

Volcker Rule Conformance Period Clarified

Volcker Rule Conformance Period Clarified

SEC CHARGES CHINA-BASED COMPANY AND OTHERS WITH STOCK MANIPULATION

FROM:  SEC
April 11, 2012
The Securities and Exchange Commission today charged that AutoChina International Limited and eleven investors, including a senior executive and director at the China-based firm, conducted a market manipulation scheme to create the false appearance of a liquid and active market for AutoChina’s stock.

According to the SEC’s complaint filed in the U.S. District Court for the District of Massachusetts, AutoChina senior executive and director Hui Kai Yan, a former AutoChina manager, and others fraudulently traded AutoChina’s stock to boost its daily trading volume. Starting in October 2010, the defendants and others deposited more than $60 million into U.S.-based brokerage accounts and engaged in hundreds of fraudulent trades over the next three months through these accounts and accounts with a Hong Kong-based broker-dealer. The fraudulent trades included matched orders, where one account sold shares to another account at the same time and for the same price, and wash trades, which resulted in no change of beneficial ownership of the shares. According to the complaint, AutoChina and the other defendants engaged in the scheme after lenders offered AutoChina unfavorable terms for a stock-backed loan due to low trading volume in its stock.

“AutoChina and the other defendants engaged in a brazen manipulation of AutoChina’s stock to obtain favorable loan terms,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “The SEC will hold accountable publicly-traded companies, including foreign companies, that violate the U.S. securities laws and disrupt the U.S. capital markets.”

David P. Bergers, Director of the SEC’s Boston Regional Office, added, “The investing public has a right to honest and fair markets. Manipulation of stocks has no place in the financial strategies of any public company.”

The SEC complaint alleges that in the three months before the defendants opened the U.S.-based brokerage accounts, the average daily trading volume of AutoChina’s stock was approximately 18,000 shares. From November 1, 2010 through January 31, 2011, the average daily trading volume increased to more than 139,000 shares. On some days, the defendants and related accounts’ trading accounted for as much as 70% of the trading of AutoChina’s stock.

According to the SEC’s complaint, several of the defendants are related to AutoChina’s Chairman and Chief Executive Officer, who at the time of the scheme owned more than 57% of the company. Three of the defendants are siblings of AutoChina’s Chairman and Chief Executive Officer and another is married to one his siblings.

The SEC’s complaint charges AutoChina; Hui Kai Yan; Rui Ge Dong; Victory First Limited; Rainbow Yield Limited; Yong Qi Li; Ai Xi Ji; Ye Wang; Zhong Wen Zhang; Li Xin Ma; Yong Li Li; and Shu Ling Li with violating Section 17(a) of the Securities Act of 1933, Sections 9(a) and 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The complaint further alleges that Rui Ge Dong; Victory First Limited; Rainbow Yield Limited; Yong Qi Li; Ai Xi Ji; Ye Wang; Zhong Wen Zhang; Li Xin Ma; Yong Li Li; and Shu Ling Li aided and abetted AutoChina’s violations of Section 17(a) of the Securities Act of 1933, Sections 9(a) and 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.

The complaint seeks a final judgment permanently enjoining the defendants from committing future violations of these provisions, ordering them to disgorge their ill-gotten gains plus prejudgment interest, imposing financial penalties and barring Hui Kai Yan them from acting as an officer or director of a public company.

MORE TROUBLE AT optionsXpress

FROM:  SEC 
Washington, D.C., April 19, 2012 – The Securities and Exchange Commission today charged a Chicago-based securities dealer affiliated with online brokerage firm optionsXpress with violating the registration provisions of the securities laws when it continued trading operations after delisting from the Chicago Board Options Exchange (CBOE) and deregistering with the SEC, apparently to avoid an audit.

The SEC’s Division of Enforcement instituted administrative proceedings against OX Trading LLC, optionsXpress, and their former CFO Thomas E. Stern, alleging that OX Trading operated as an unregistered dealer from October 2009 to November 2010 and illegally transacted in securities while not a member of a national securities association or national exchange from March 2009 to November 2010.

According to the SEC’s order, Stern terminated OX Trading’s membership with the CBOE and ended the firm’s broker-dealer registration with the SEC. Meanwhile, OX Trading quietly continued to conduct trading through a customer account at optionsXpress. Stern, who also was OX Trading’s chief compliance officer, later fabricated and backdated an allegedly exculpatory letter purporting to demonstrate that he had properly informed CBOE that OX Trading would deregister and become a customer of optionsXpress.

Earlier this week, the SEC charged optionsXpress and Stern for their roles in a naked short selling scheme.

“OptionsXpress, OX Trading, and Stern have displayed a profound disregard for regulators, compliance obligations, and the regulatory requirements that dealers must satisfy for the privilege of operating in our markets,” said Daniel M. Hawke, Chief of the SEC’s Market Abuse Unit. “Registration of brokers and dealers is a fundamental part of the regulatory structure and provides the foundation upon which many other investor protections are built.”

According to the SEC’s order, OX Trading and optionsXpress became wholly-owned subsidiaries of The Charles Schwab Corporation in September 2011. OX Trading, which originally registered with the SEC in 2008, was created to provide price improvement on orders from optionsXpress customers and to profit from those trades. OX Trading received electronic requests for quotes (RFQs) from optionsXpress. These RFQs allowed OX Trading to determine whether it wanted to be the counterparty to an optionsXpress customer’s order. OX Trading allegedly made money when it traded as a counterparty to optionsXpress customer orders and hedged the positions created by those trades.

According to the SEC’s order, a CBOE examiner conveyed to Stern in early 2009 that OX Trading was required to have an annual audit based on its CBOE membership status. Despite CBOE’s request, Stern refused to pay for an audit and subsequently terminated OX Trading’s CBOE membership on March 2, 2009. Nonetheless, OX Trading continued to conduct the same trading through a customer portfolio margin account at optionsXpress. Stern did not inform the CBOE that OX Trading would continue its operations as a customer of optionsXpress. He later attempted to furnish the fabricated and backdated letter to SEC investigators in a phony attempt to prove otherwise.

According to the SEC’s order, after Stern was contacted by the SEC’s Division of Trading and Markets, Stern filed a form with the SEC on Aug. 18, 2009, to deregister OX Trading as a broker-dealer. The deregistration became effective on Oct. 17, 2009. According to an internal e-mail sent by Stern, OX Trading “stalled as long as we could” in deregistering. OX Trading continued to trade through the customer portfolio margin account at optionsXpress.

The SEC’s Division of Enforcement alleges that CBOE identified the OX Trading customer account during an exam of optionsXpress in late 2009. CBOE requested an explanation about why OX Trading was not registered with the SEC as a broker-dealer. In an internal e-mail about CBOE’s request, Stern stated, “I am happy to spin this however it needs to be.” Stern then sent CBOE a letter containing numerous factual inaccuracies and no legal opinion or analysis about OX Trading’s registration status. CBOE sent Stern another letter in June 2010 informing him that it believed OX Trading was functioning as a dealer and needed to either cease operations or obtain a written opinion from the SEC confirming that OX Trading was not required to register. OX Trading did neither.

According to the SEC’s order, OX Trading eventually acquired a CBOE trading permit and registered again with the SEC effective Nov. 16, 2010.

As alleged in the SEC’s order, OX Trading violated Sections 15(a) and 15(b)(8) of the Exchange Act, and Stern and optionsXpress caused and willfully aided and abetted OX Trading’s violations.

The SEC’s investigation was conducted by Deborah Tarasevich, Jill Henderson, and Paul Kim. Market Surveillance Specialist Brian Shute and Market Abuse Trading Specialist Ainsley Fuhr provided assistance with the investigation. The SEC’s litigation will be led by Frederick Block.

SEC GETS JUDGMENTS ON CONSENT AGAINST DIAMONDBACK CAPITAL MANAGEMENT LLC

FROM:  SEC 
April 10, 2012
SEC v. Spyridon Adondakis et al., Civil Action 12-CV-0409 (SDNY)(HB)
SEC Obtains Final Judgments on Consent against Diamondback Capital Management LLC
The SEC announced that the Honorable Harold Baer, Jr., United States District Judge, United States District Court for the Southern District of New York, entered a Final Judgment on Consent as to Diamondback Capital Management LLC (“Diamondback”) on April 6, 2012, in the SEC’s insider trading case, SEC v. Spyridon Adondakis et al., Civil Action 12-CV-0409 (SDNY) (HB).

The SEC filed its complaint on January 18, 2012, charging two multi-billion dollar hedge fund advisory firms – including Diamondback – as well as seven fund managers and analysts involved in a $78 million insider trading scheme based on nonpublic information about Dell’s quarterly earnings and other similar inside information about Nvidia Corporation.

The SEC’s complaint alleged that in 2008 and 2009, Jesse Tortora, an analyst at Diamondback, obtained inside information about quarterly earnings reports of both Dell and Nvidia and passed that information to Todd Newman, a Diamondback portfolio manager, who used the information to execute trades on behalf of hedge funds managed by Diamondback. These illegal trades in Dell and Nvidia securities resulted in millions of dollars in illicit gains for Diamondback.

The Final Judgment against Diamondback: (1) permanently enjoins the firm from violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), and Exchange Act Rule 10b-5; and (2) orders it to pay disgorgement of $5,173,000 plus pre-judgment interest of $832,751.35, for a total of $6,005,751.35, provided that the amount Diamondback owes would be credited, dollar for dollar, by amounts paid pursuant to a non-prosecution agreement between Diamondback and the U.S. Attorney’s Office for the Southern District of New York; and (c) orders it to pay a civil penalty in the amount of $3,000,000.

U.S. TREASURY OFFICIAL'S REMARKS ON WALL STREET REFORM

FROM:  U.S. DEPARTMENT OF THE TREASURY
Wall Street Reform for U.S. Department of the Treasury
As prepared for delivery
NEW YORK – Good afternoon.  It is a privilege to address the International Section of the American Bar Association, and to be speaking about international regulatory reform. The subject matter is particularly timely given that the world’s finance ministers will gather in Washington, D.C. for the G-20 this weekend.

We have learned from recent events, including the financial crisis, that financial systems and markets around the world are more integrated than ever.  Therefore, financial reforms around the globe must be consistent and convergent.

I will touch on three key priorities that were agreed upon by the G-20 – capital, resolution, and OTC derivatives – as well as insurance regulation.
We are transitioning now from regulatory design to implementation.  We must acknowledge that the task is both difficult and complex. We must work together through the G-20 and the Financial Stability Board to make the new rules effective. We all share a common interest in a global financial system that is safe and resilient, and that supports growth.

The Importance of Reform
Let me begin by retreading familiar ground: the financial crisis revealed that the risks facing our system can be correlated and crosscutting, and that they can affect multiple firms, markets, and countries simultaneously. The crisis laid bare the fundamental weaknesses of the previous financial regulatory infrastructure.
To preserve financial stability, it became essential to establish a regulatory structure that could properly assess the financial system as a whole, not simply its component parts – a regulatory structure in which the failure of one firm, or problems in one corner of the system, would not risk bringing down the entire financial system.  It was important to establish a modern regulatory framework that could keep pace with financial sector innovations, restore market discipline, and safeguard financial stability in both the United States and abroad.  The United States has played a leading role in this global financial reform by enacting the Dodd-Frank Act.

Some have argued that these new rules and standards put U.S. financial firms at a competitive disadvantage.  While we must always work towards having a level competitive playing field, I believe such arguments are misplaced.
First, by moving quickly, we in the United States have been able to lead from a position of strength in setting the international reform agenda.

Second, there is already evidence that our actions – both the immediate response to the crisis and permanent reforms under the Dodd-Frank Act – have bolstered the recovery of the U.S. financial system.  Bank balance sheets are stronger. Tier 1 common equity at large bank holding companies has increased by more than 70 percent or by $560 billion since the first quarter of 2009. Additionally, at the four largest bank holding companies, for example, reliance on short-term wholesale financial debt has decreased from a peak of 36 percent of total assets in 2007 to 20 percent at the end of 2011. The firms’ liquidity positions are more robust and their funding sources are more reliable. Firms have significantly reduced leverage. Recent stress tests showed that the bank holding companies are better able to withstand significant shocks.

Third, I believe that consumers, investors, and businesses feel more secure when they deal with financial institutions that are well-regulated and transparent, because these attributes engender trust. Trust is essential for the financial system to perform its most basic functions, including credit intermediation. For many years, investors from all over the world have trusted the U.S. financial system. Regulation that is both strong and sensible is essential to continue that trust.

Over the past three years, we have made substantial progress in restoring this trust to our financial system and thereby improving financial stability. Long-term economic growth and credit intermediation are only sustainable under a model in which there is confidence in financial stability.

International Coordination
All of this being said, it is nevertheless important to remember that financial systems are interconnected and that risks both transcend and migrate across national borders. Therefore, we must work towards building a system where there is broad global agreement on the basic rules of the road.

Global coordination is important not only for maintaining a level playing field, but also for promoting financial stability.  We can ill afford the risk of regulatory arbitrage.  If riskier activities migrate unchecked to jurisdictions with inadequate rules and supervision, the threats that will emerge will have implications not just for the host country, but for the global financial system. The financial crisis exposed the failure of weak regulation.

Europe has taken important steps toward reform.  The EU is working through its most extensive financial services reform.   It has proposed or adopted around thirty reform measures, including almost all of the key measures agreed to by the G-20.  The United States and the EU are aligned on the fundamental goals of regulatory reform, and are united by a shared view that it is necessary to complete at an international level the work that is underway.  Treasury and U.S. regulatory agencies have worked closely with our counterparts in the European Commission and the European Supervisory Agencies to align our regulations more closely.

It is unlikely that we and our European counterparts will attain perfect alignment.  But most of the differences between us are technical, not matters of principle.  While we must work diligently to resolve our technical differences, we should not let them overshadow our shared commitment to reform. We must also see to it that other regions follow through on implementing reforms, particularly Asia, given the importance of financial centers like Hong Kong, Singapore, and Tokyo. The global financial system will continue to strengthen as a result of our efforts. Backtracking on reforms is not an option.

G-20 and the Joint Reform Agenda
The G-20 has been, and will continue to be, a key vehicle for coordinating our reform efforts. Since the first meetings of the G-20, and especially since the Pittsburgh meetings during the height of the financial crisis in 2009, the Group has worked to increase the strength and effectiveness of the international regulatory framework through a comprehensive agenda for reform. This agenda has been reaffirmed and further developed at each subsequent Summit.  The Financial Stability Forum, which was expanded and strengthened as the Financial Stability Board (FSB) in 2009, has also played a key role in this process, with support from the global standard-setting bodies.

This year in the G-20, the United States is emphasizing progress on implementation in three key areas: capital, resolution, and OTC derivatives.  Let me now turn to discussing these three priorities as well as international coordination around insurance, which will also be an area of focus in the coming year.

Capital
The crisis showed that financial institutions were not sufficiently capitalized to withstand significant market pressures.  To maintain financial stability, taxpayers in countries across the globe had to provide capital support to financial institutions in order to prevent their failure.  There was little question that, going forward, banks needed to be more resilient, with better quality capital buffers.  

The international regulatory community acted with dispatch and urgency to achieve consensus on Basel 2.5 and Basel III capital standards.  The new Basel capital standards provide a uniform definition of capital across jurisdictions, and it requires banks to hold significantly more and higher-quality capital.  The reforms to the Basel Capital Standards also establish a mandatory leverage ratio and a liquidity coverage ratio.
More work remains with respect to the Basel Capital Standards.  International agreement on standards must be followed with implementation by G-20 members.  Moreover, important debates continue around issues such as liquidity run-off ratios and measurement of capital deductions. The Basel Committee is now working toward more consistent measurement of risk-weighted assets across jurisdictions.

While these points are relatively technical, it is important that the new rules be consistent not only in principle, but also in practice. Consistent cross-border application of capital standards is important to maintaining a level playing field.

Resolution
Strengthening cross-border resolution regimes is complicated.  But it is a critically important topic.

The U.S. experience with Lehman Brothers showed the potentially devastating consequences to financial stability of the disorderly bankruptcy of a financial firm. Thus, the Dodd-Frank Act provides for orderly resolution of financial companies, including non-bank financial institutions. The FDIC and Federal Reserve have already adopted a number of rules pursuant to these new authorities, including a “living wills” rule that requires large bank holding companies and designated nonbank financial companies to prepare resolution plans.  The largest bank holding companies will submit the first living wills in July.
The goal of international convergence was furthered this year when the G-20 endorsed the “Key Attributes of Effective Resolution Regimes for Financial Institutions.”   This new international standard addresses such critical issues as the scope and independence of the resolution authority, the essential powers and authorities that a resolution authority must possess, and how jurisdictions can facilitate cross-border cooperation in resolutions of significant financial institutions. The Key Attributes provide guidelines for how jurisdictions should develop recovery and resolution plans for specific institutions and for assessing the resolvability of their institutions.  This new international standard also sets forth the elements that countries should include in their resolution regimes while avoiding severe systemic consequences or taxpayer loss.

Therefore, much progress has already been made and even more will be completed by the end of this year: cross-border crisis management groups for the largest firms have been established, additional cross-border cooperation agreements will be put in place, and recovery and resolution plans are being developed.

Derivatives
The crisis also showed that we did not have a sufficient understanding of derivatives, which are an important means of interconnection between firms.  The flaws attendant to this area of financial transactions were many: poor access to useful data such that, at critical times, neither supervisors nor counterparties knew who owed what to whom; poor risk management such that firms were not able to satisfy their contractual obligations with respect to collateral; and a generally fragmented and opaque market. It is common ground that the lack of oversight in the derivatives markets exacerbated the financial crisis.
The Dodd-Frank Act creates a comprehensive framework of regulation for the OTC derivatives markets.  The elements of this framework include regulation of dealers, mandatory clearing, trading, and transparency.  The framework established under the Dodd-Frank Act is consistent with that of the G-20.  The CFTC and SEC are well into their rule-making process.  Once again, the United States and the EU have closely cooperated in this area, and have adopted parallel approaches to important issues such as central clearing, trading platforms, and reporting to trade repositories.

While the reforms set forth a framework for on-exchange-traded derivatives, it is also important for us to make progress on establishing a global regime for margin for bespoke, un-cleared derivatives transactions.  Both the United States and the EU support international work on global margin standards for trades that are not cleared through a central counterparty. Margin requirements are critical to promoting the safety and soundness of the dealers, and thereby lower risk in the financial system.
While we have made some progress, there is still much work to be done on derivatives, including completing the implementation efforts and meeting agreed G-20 timetables.

Insurance
Finally, I would like to turn to insurance regulation.  Important strides have been made in this area. The Dodd-Frank Act created and placed within the Treasury Department the Federal Insurance Office (FIO). While FIO is not a regulator, it has broad responsibilities to monitor all aspects of the insurance industry and is the first federal office in this sector. Among its duties, FIO is charged with coordinating federal efforts and developing federal policy on prudential aspects of international insurance matters, including representing the United States in the International Association of Insurance Supervisors, or IAIS. Notably, FIO recently joined the Executive Committee of the IAIS.

FIO’s establishment coincides with the rapid internationalization of the insurance sector and work ongoing in various international regulatory bodies that will affect U.S.-based companies operating around the world. FIO’s international priorities include the IAIS initiative to create a common framework for the supervision of internationally active insurance groups, or ComFrame. FIO is also engaged in the IAIS work stream to develop a methodology that will identify globally significant insurance institutions, an assignment given to the IAIS by the Financial Stability Board. Finally, FIO is leading an insurance dialogue between the United States and the EU that aims to establish a platform for insurers based on both sides of the Atlantic to compete fairly and on a level playing field.

Conclusion
We must continue to work with our partners in the G-20 and the Financial Stability Board to ensure a consistent international financial reform agenda.  It is not enough to mitigate risk within the United States.  Reform must be global in nature.

But, financial reform cannot just respond to events of the past.  It must be forward-looking and it must help lay the foundations for sustainable growth.  Financial reform, embodied by responsible and robust regulation, is critical to establishing and maintaining confidence.  Confidence is critical for long-term financial stability and growth.
Our past experience confirms our current judgment.  In the decades following the Great Depression, the United States set the highest standards for disclosure and investor protection, the strongest protections for depositors, and sophisticated market rules. We did not lower our standards even when others might have.  Financial regulation became a source of strength for our financial system and led to a period of significant growth and prosperity.

Today, as our predecessors did in the wake of the Great Depression, we also have the opportunity to restore trust in the global financial system through a smart regulatory framework that could support sustainable economic expansion.
Thank you.