Gary DeWaal's Bridging the Week: August 12-16 and 19, 2013

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Published Date : August 19, 2013

This week, Bridging the Week reviews "Lessons Learned" from enforcement actions brought against two former JP Morgan traders as well as:

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It was a somewhat slow regulatory news week for the worldwide financial services industry the week of August 12-16, 2013, punctuated by the criminal indictment and civil action in the United States against two mid-level employees of JP Morgan related to last year's London Whale incident. However, some other important matters also deserve attention.

BCP for Financial Intermediaries

First, the US CFTC, SEC and FINRA jointly issued guidance related to business continuity planning following their survey of financial service industry members impacted by the devastating destruction of Superstorm Sandy in the northeast United States during October 2012. Although there is nothing groundbreaking in their recommendations, the Guidance reminds firms of the importance of routinely reviewing and updating their business continuity plans, as well as regularly communicating its components to all employees.

The Guidance also emphasizes the importance of firms ensuring that their critical vendors have adequate business continuity plans too.
Other practical suggestions include that firms should consider:

Although these recommendations are issued to US financial service firms, they clearly have worldwide application.

Resolution and Recovery Plans for FMIs; Risk Management for SIDCOs 

Second, last week the International Organization of Securities Commissioners and the Committee on Payment and Settlement Systems (CPSS) issued a consultative report related to the need for financial market intermediaries to maintain effective recovery plans following events that might jeopardize their viability and financial strength and threaten their ability to provide critical services without the intervention of regulatory authorities. During the same week, the CFTC also issued enhanced risk management standards for systemically important derivatives clearing organizations (SIDCOs).

In the CPSS/IOSCO report, for which comments are due by October 11, the regulatory organizations provide an overview of some of the tools that so-called financial market intermediaries or FMIs should include in their recovery plans including a discussion of events that may trigger the use of such tools.  (As background, FMI's are multilateral centralized  systems that perform payment, clearing, settlement or recording services, e.g., trade repositories, clearing houses, and securities settlement systems.)
CPSS/IOSCO divide these tools into five categories, namely tools to:

The bottom line, according to CPSS/IOSCO, is that whatever tools are adopted by FMIs, they must be timely, reliable and have a strong legal basis, and most importantly they must be transparent, so that those who might have to bear the losses and liquidity shortfalls know in advance how the allocation of losses and shortfalls will play out in a recovery situation.

Although CPSS/IOSCO emphasizes the needs for FMIs that are central clearing counterparties to consider a number of possibilities among their recovery plans including (1) cash calls on members; (2) initial and variation margin haircutting; and (3) forced allocation of contracts, the regulators fairly discuss the downside of employing such possibilities – including certain pro-cyclical dangers.

It will be up to participants in the industry to help CPSS and IOSCO evaluate these pros and cons, and perhaps offer alternative suggestions. The implications of their final Guidance, however, will have great implications as to the willingness of ultimate customers to embrace more willingly (or not) the central clearing model, as well as of firms to be members of CCPs.

The CFTC's final Risk Management Standards for SIDCOs relate exclusively to a narrow subset of FMIs, namely systematically important derivatives clearing organizations in the US, of which currently there are only two: the Chicago Mercantile Exchange, Inc. and ICE Clear Credit LLC. These standards become effective on October 15 and must be complied with by December 31.

In general, the CFTC requires SIDCOs

Again, in rejecting the ability of SIDCOs to rely on the value of assessments in calculating their financial resources, the CFTC acknowledged the "potential pro-cyclical effects of assessments" on members.

Both the CPSS/IOSCO consultative document and the CFTC final risk management standards are important documents worth reviewing and considering, and comparing to proposals for recovery and resolution by CCPs also issued recently by ISDA – the industry organization.

As an aside and also worth considering, are the CFTC proposed rules for DCOs to align with international standards that also were issued last week. Comments to these proposed rules are due by September 16, 2013.

CFTC Adopts Substitute Compliance Regime for Certain Funds; All CPOs and CTAs benefit Too

Last week the CFTC also adopted final rules related to advisors to certain investment funds that will now be permitted to rely on substituted compliance with relevant SEC rules to meet their obligations under similar CFTC rules. This necessity came about  because of such advisors' obligation now to register as commodity pool  operators under the CFTC regime. Good news: in some cases these rules also benefit ordinary CPOs and CTAs too.

For additional information, check out a separate article on this matter on the Gary DeWaal and Associates website.

And briefly: Last week also:

The London Whale Enforcement Actions

And finally, last week the US Attorney for the Southern District of NY filed criminal charges, and the Securities and Exchange Commission filed civil charges in Federal Court in NY, against two former traders of JP Morgan in connection in what has become known as the London Whale incident.

Generally, both individuals –Julien Grout, and his supervisor, Javier Martin-Artajo -- are cited for over-valuing certain investments of JP Morgan in early 2012 to hide growing losses in such investments. Instead of using a mid-market valuation for the over the counter instruments at issue, Grout, in response to the demands of his supervisor Martin-Artajo, used prices for valuation chosen to deliberately minimize an internally reported loss. These prices were entered into JP Morgan's systems and reported to management, so that losses were understated.

Although neither JP Morgan nor Bruno Iksil -- the so-called actual London Whale -- were charged in any action, the SEC alleged that, during the relevant time, JP Morgan,

"…failed to furnish to the Commission, in accordance with [its] rules and regulations …such financial reports as the Commission has prescribed, and JPMorgan failed to include, in addition to the information expressly required to be stated in such reports, such further material information as was necessary to make the statements made therein, in light of the circumstances in which they were made, not misleading."

If in fact the US Attorney's office and the SEC investigated Mr. Iksil and declined to charge him, it's a credit to both organizations that they recognize that in fact bad things sometimes happen at firms despite their being good people at the top of supervisory chains who try to do the right thing. This doesn't mean that supervisors will never be named in enforcement matters; but it means individuals may be spared from enforcement actions if firms have reasonably good policies and procedures and supervisors follow those procedures and are reasonably pro-active too. It may not help the company itself, however. Indeed, the media suggests the international regulatory interest in this matter is far from over.

For more information, see:

ASIC: Rules on Dark Liquidity and High Frequency Trading:,+high-frequency+trading?openDocument
CFTC: Dissent of Commissioner O'Malia:
CFTC: Final Enhanced Risk Management Standards for SIDCOs:
CFTC: Final Rules for Registered Investment Companies to Register as CPOs (Substituted Compliance):
CFTC: Proposed Rules for DCOs to Align with International Standards:
CFTC, FINRA and SEC:  Joint Review of Firms' Business Continuity and Disaster Recovery Planning:
CPSS/IOSCO: Consultative Report on the Recovery of FMIs:
FIA, FSR SIFMA: Comment Letter of Cross Border Exemptive Order:,%203038-AD85).pdf
ISDA: Loss Allocation at the End of the Waterfall (see article of this name):
SEC: Civil Action against Javier Martin-Artajo and Julien Grout:
US Attorney (SDNY) Charging Documents against Javier Martin-Artajo and Julien Grout:

The information contained in this article is not legal advice. For legal advice, please consult with your attorney. The information in this article is derived from sources believed to be reliable as of August 19, 2013, but no representation or warranty is made regarding the accuracy of any statement. To ensure compliance with requirements imposed by U.S. Treasury Regulations, Gary DeWaal and Associates LLC informs you that any U.S. tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Gary DeWaal and Associates may represent one or more entities mentioned in this article.


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