THE SEC’S NEW APPROACH TO ECONOMIC ANALYSIS IN RULE WRITING

Economic analysis in rule making has become a critical issue for the SEC. The D.C. Circuit has rejected two Commission rules in recent years, expressing concern about the level of analysis. The Office of the Inspector General issued a report earlier this year which considers cost benefit analysis regarding certain Dodd-Frank rules. The GAO issued a report addressing the level of analysis for Dodd-Frank rules late last year. Congress is considering proposals which would require additional economic analysis in rule making.

On April 17 SEC Chairman Mary Schapiro told Congress that the SEC is involving its staff economists earlier in the rule writing process, expects to add 20 economists to the RSFI in the next few months and is requesting funding for 20 more economists.Testimony Concerning Economic Analysis in SEC Rulemaking, before the Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs Oversight and Government Reform Committee (here).

After reviewing the statutory predicates for Commission rule making and the difficulties of conducting the appropriate analysis, the Chairman informed the Committee that the agency is implementing new guidance for conducting economic analysis developed by its General Counsel and Chief Economist based on the GAO and OIG reports as well as other sources. Under the new approach to economics in rule writing the agency is:

• Involving RSFI economists earlier and in a more comprehensive fashion;

• Assuring the rule releases clearly identify the justification for the proposal;

• Where a statute directs rulemaking, considering its overall impact;

• Where feasible, quantifying the costs and benefits and if not explaining that fact;

• Including a more integrated economic analysis into rule releases;

• Giving more explicit encouragement to those furnishing comments to provide a more complete economic analysis; and

• Having a greater discussion of reasonable alternatives not chosen.

A fundamental change made by the Commission is to utilize the expertise of RSFI economists in the rule writing process at the earliest stage and throughout the course of writing proposals. Under the new guidance the Commission is also attempting to clearly identify the justification for the proposed rule, define the baseline against which the economic impact of the rule is measured, discuss reasonable alternatives and analyze the economic consequences of the proposed rule and the principal regulatory alternatives. Finally, as recommended by the OIG report, in some recent releases the Commission is including an integrated economic analysis rather that one which is segmented into sections. Further improvements in the economic analysis will be made in the coming months.

NEW STANDARDS FOR FINANCIAL MARKET INFRASTRUCTURES

The Committee on Payment and Settlement Systems or CPSS and the Technical Committee of the International Organization of Securities Commissioners or the IOSCO (whose members include the SEC and the CFTC) published the final report of the Principles of Financial Market Infrastructures or FMIs. This report replaces earlier published standards. The CPSS and IOSC expect the principles to be key in the regulation of FMIs.

FMIs that facilitate the clearing, settlement and recording of monetary and financial transactions are critical in fostering financial stability. The report details twenty-three principles grouped into ten categories regarding the governance and operation of FMIs. The new principles are designed, according to the Bank for International Settlements, to “ensure that the infrastructure supporting global financial markets is robust and thus well placed to withstand financial shock.” The principles include:

Category 1, General organization focuses on governance and the management of risks. It notes that firms should have governance arrangements that are clear and transparent and which promote safety and efficiency while having a sound risk-management framework.

Category 2, Credit and liquidity risk management is keyed to having effective measures to monitor and manage credit exposures including the resources sufficient to cover a wide range of potential stress categories. This includes the default of two participants and their affiliates. Policies should also that require collateral with low credit, liquidity and market risk. Margin should cover credit exposures to participants for all products and the firm should effectively measure, monitor and mange liquidity risk.

Category 3, Settlement is concerned with the finality of settlement which should be at a minimum by the end of the value date or, preferably, intraday or in real time.

Category 4, Central securities depositories notes that a CSD should have appropriate rules and procedures to help ensure the integrity of the securities issued and minimize and manage the risks. If there is two linked obligations the CSD should eliminate principal risk by conditioning final settlement of one on the other.

Category 5, Segregation and portability should be provided for as to the positions and the collateral.

Category 6, General business and operational risk management focuses on general business risk including suggesting that sufficient liquid net assets funded by equity be held to cover potential general business loses, custody and investment risks and the management of operational risk.

Category 7, Access and participation requirements notes that an FMI should have objective, risk-based and publicly disclosed criteria for participation which permit fair and open access.

Category 8, Efficiency and effectiveness provides that the FMI should be efficient in meeting the requirement of its participants and the markets it serves while using procedures to facilitate efficient payment, clearing, settlement and recording.

Category 9, Disclosure of rules, key procedures and market data provides that the FMI should have clear and comprehensive rules and procedures and provide for timely and accurate access to data by the relevant authorities and the public in view of their respective needs.

Category 10, Responsibilities of central banks, market regulators and other relevant authorities concerns the regulation and supervision of FMIs, the oversight of their powers and resources, their disclosure policies and cooperation with authorities.