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SEC, CFTC make their pitch for boosted budgets

Joe Mont | July 5, 2017

Its that time of the year again that sends chills though government agencies. Against the backdrop of a new president in office for the first time in eight years, budget negotiations are afoot.

In recent days the Senate Appropriations Committee, through various subcommittees, has held hearings with agency heads to discuss Fiscal Year 2018 budgets. Chairman Shelley Moore Capito (W.Va.) presided over a June 27 hearing with the Securities and Exchange Commission and Commodity Futures Trading Commission.

Both agencies are seeking increases for fiscal year 2018. The SEC is requesting $1.8 billion, which is $242 million, or 15 percent, higher than FY 2017. Since FY 2000, the SEC budget has grown from $377 million to now $1.6 billion.

The CFTC is requesting $281.5 million, 11 percent more than FY 2017. For comparison, the CFTC was funded at $62.7 million in fiscal year 2000 and the budget has now reached $250 million.

“We’re also interested in hearing more about efforts to defend against cyber threats to investors and financial market infrastructure, as well as efforts to ease regulatory burdens,” Capito said. “Your jobs have become even more challenging with the rise in automated trading and constant technological innovation — including areas such as financial technology or FinTech —and the need to operate in markets undergoing digital transformation.”

SEC Chairman Jay Clayton said $1.602 billion requested for FY 2018 is essentially the same as its FY 2017 appropriation.

“The investing public, and Americans more generally, will receive significant value in return for the SEC’s $1.602 billion budget,” he said.

With a workforce of about 4,600 staff, the SEC oversees approximately $75 trillion in securities trading annually on U.S. equity markets; the disclosures of 8,800 public companies including 77 of the world’s 100 largest companies; and the activities of over 26,000 registered market participants including investment advisers, mutual funds, exchange traded funds, broker-dealers, and transfer agents.

On a typical day, investors and other market participants view or download more than 50 million disclosure documents filed on EDGAR.

Clayton reminded the subcommittee that the SEC’s funding is deficit-neutral. “Whatever amount Congress appropriates to the agency will, by law, be fully offset by transaction fees, and will not impact the deficit or the funding available for other agencies,” he said. The current transaction fee rate is just over two cents for every $1,000 in covered securities sales.

The SEC also has been a net contributor to the U.S. Treasury “in other ways that are not directly related to our appropriations,” Clayton said. By law, companies pay a fee to the SEC at the time they register securities for sale. For FY 2018, the fee rate will be set at a level sufficient to collect $620 million. A portion of these collections ($50 million) will be put into the Reserve Fund, which the agency devotes to information technology improvements, while the remaining $570 million will be deposited in the general fund of the U.S. Treasury

The FY 2018 request seeks to solidify and maintain SEC progress in key areas, Clayton said.  The agency will continue to work toward more efficient internal operations, including through automation, streamlined internal processes, and better use of data.

“For example, we will continue to develop and leverage our capabilities for risk analysis to inform our decision making, including how most efficiently to use staff resources,” he said. “Given the pace of change in today’s capital markets, it is more important than ever that agency operations be nimble so that we can direct resources where they are needed most.”

The FY 2018 budget “will enable the SEC to have a robust program to monitor, investigate, and enforce compliance with the federal securities laws,” Clayton said. More than 50 percent of the requested resources will be invested in the agency’s enforcement and examination programs.

“These resources enable the agency to root out fraud and wrongdoing in our financial system,” he said. “They also allow us to evaluate broker-dealers, investment advisers, and other regulated entities that interact with investors for compliance with investor protection rules.”

The Commission regularly obtains orders requiring securities violators to disgorge illegal profits and pay penalties. In FY 2016, these amounts totaled more than $4 billion.

“Our priority is to distribute these funds to harmed investors wherever reasonably possible,” Clayton said.

The budget request will also enable the SEC’s national examination program, led by the Office of Compliance Inspections and Examinations to focus on conducting risk-based examinations of registered entities, including broker-dealers, investment advisers, investment companies, municipal advisors, national securities exchanges, SROs, transfer agents, and clearing agencies to evaluate their compliance with applicable regulatory requirements.

“This is an example of an area where flexibility is necessary,” Clayton said.

Registered investment advisers now manage more than $70 trillion in assets, more than three times 2001 levels. In 2016, the SEC reassigned approximately 100 staff to the national examination program’s investment adviser examination unit.

“As a result of this shift and the introduction of efficiencies, the SEC is on track to deliver a 20 percent increase in the number of investment adviser examinations in the current fiscal year,” Clayton said.

For FY 2018, OCIE anticipates being able to deliver a further 5 percent increase in the number of investment adviser exams.

“I expect that for at least the next several years we will need to do more each year to increase the agency’s examination coverage of investment advisers in light of continuing changes in the markets,” Clayton said. “In the coming fiscal year, OCIE plans to increase the number of inspections to assess compliance with Commission rules designed to ensure that the cyber-security infrastructure that is critical to the U.S. securities markets is secure and resilient.”

OCIE also will continue to bolster its risk-based approach to exam selection through the continued development of data analytics tools. “These tools help us identify activities that may warrant further examination and efficiently focus our examination efforts,” Clayton said.

While much progress has been made, “the SEC can and should strive to do more to enhance capital formation,” Clayton said. Support for the FY 2018 budget request, he added, will enable the staff to develop and present to the Commission rulemaking initiatives aimed at promoting firms’ access to capital markets to generate economic growth while fostering important investor protections. The budget will also enable the agency to devote resources to staff the new Office of the Advocate for Small Business Capital Formation.

In the near future, the SEC plans to commence a nationwide recruitment effort to identify and hire a Small Business Capital Formation Advocate who will serve as the head of this office,” Clayton explained. The Office will provide assistance to small businesses and recommend ways that the regulatory environment might be improved.

The $240 million that the SEC plans to spend on information technology in FY 2018 “is quite modest, by way of comparison, to the amounts that the major Wall Street firms spend on their own information technology systems,” Clayton said. For example, in 2016 one large financial institution alone spent more than $9.5 billion on technology firm-wide, with $3 billion of that dedicated toward new initiatives. Another large financial institution spent $6.6 billion in 2016 on technology initiatives.

The FY 2018 budget request relies on continued access to the SEC’s Reserve Fund.

“These funds, which have been dedicated to technology, have been important in our efforts to keep pace with the rapid technology advancements occurring in areas regulated by the SEC, as well as meeting emerging cyber-security challenges,” Clayton said. “The continued availability of the Reserve Fund historically has allowed us to commit to critical, long-term technology initiatives that otherwise may have been more difficult for us to execute.”

Key technology initiatives that would be supported with the FY 2018 request include:

  • Expanding data analytics tools to integrate and analyze the large and ever-increasing volume of financial data we receive, enabling us to detect potential fraud or suspicious behavior earlier and allocate resources more effectively;
  • Iimproving the examination program through risk assessment and surveillance tools that help identify high-risk areas for further examination;
  • Increasing investments in cyber-security, including strengthening our capabilities for monitoring and avoiding advanced persistent threats;
  • Enhancing additional systems that support the enforcement program, including applying sophisticated algorithms that foster the detection of potential insider trading and manipulation;
  • Improving access and usefulness of information available to the public through the EDGAR electronic filing system; and
  • Investing further in business processes automation and enhancements including the retirement of legacy systems.

J. Christopher Giancarlo, the CCTC’s acting chairman, said the agency’s FY 2018 request placed importance on specific capabilities that will “allow the Commission to enhance economic cost benefit analysis capabilities; strengthen examinations capabilities over swaps clearing houses; and address the regulatory challenges related to market innovation.”

The Commission is requesting $281.5 million and 739 full-time equivalents for fiscal year 2018 operations. It is an increase of $31.5 million and 36 FTE over the FY 2017 level.

The $31.5 million in additional funds “is not a formulaic or superficial number, but a thorough and informed assessment of what the CFTC needs to execute its mission in FY 2018,” Giancarlo said. The CFTC has already identified several areas in which the agency can run more efficiently and save taxpayer dollars, he added. Reviews also discovered areas where it needs additional investment.

“The era of Dodd-Frank implementation at the CFTC is now drawing to a close. It is time for the agency to resume normalized operations and practices,” Giancarlo said. “That means a return to greater care and precision in rule drafting, more thorough econometric analysis, less contracted time frames for public comment and a reduced docket of new rules and regulations to be absorbed by market participants.”

It also means that the CFTC will embrace the Trump Administration’s directive that each federal agency minimize the costs incurred by regulation, he added. Normalizing operations at the CFTC also means working cooperatively with other federal market regulators, like the SEC. Where appropriate, the Commission should also look to delegate responsibility to the National Futures Association and other SROs for certain compliance matters.

Additional resources were also requested for economic analysis and boosting the CFTC’s analytical expertise and monitoring of systemic risk in the derivatives markets, in particular with regard to central counterparty clearinghouses.

“This includes the expansion of sophisticated econometric and quantitative analysis devoted to risk modeling, stress tests, and other evaluations necessary for market oversight,” Giancarlo said.

“A common criticism of the rule-making process has been the lack of quantitative assessments of costs and benefits, he explained. “While there was a paucity of relevant data for Dodd-Frank implementation, we believe that market participants and the public expect the CFTC to leverage the data sources now available to inform future rulemaking.”

The current staff dedicated to economic analysis is “inadequate to meet appropriate standards for econometric analysis required by a regulatory agency with oversight of more than 35 to 45 percent of the global derivatives markets.”

The Commission is requesting additional resources that would strengthen its examinations capability and “enable it to keep pace with the explosive growth in the number and value of swaps cleared by designated clearing organizations, pursuant to global regulatory reform implementation,” Giancarlo said.

Currently, there are 16 DCOs registered with the Commission and there is one pending application for registration. The Commission projects that the number of DCOs will continue to expand in FY 2018, and volume will continue to grow at existing DCOs.

“The growth in volume has been accompanied by an increase in the complexity of products,” he said. “For example, the risks posed by credit default swaps differ from those posed by interest rate swaps. Accordingly, DCOs have developed a large number of individualized margin models and other risk management tools to address these risks. This, in turn, generates a corresponding increase in the complexity of the Commission’s oversight responsibilities.”

The CFTC is also requesting additional funds to increase staffing and resources to address financial technology innovation, commonly known as FinTech.

The Commission aims to address three fundamental issues arising from transformations in FinTech: how it should leverage FinTech innovation to make it a more effective regulator; how FinTech can help identify rules and regulations that need to be updated for relevance in digital markets; and the role of the Commission in supporting U.S. FinTech innovation in regulated markets.

“Breaking digital innovations present equal regulatory challenges,” he added.

These innovations include “big data” capability to enable more sophisticated data analysis and interpretation; artificial intelligence to guide highly dynamic trade execution; ‘smart’ contracts that value themselves and calculate payments in real-time; behavioral biometrics that can detect and combat online fraud; and distributed ledger technology, more commonly known as blockchain.

“We are seeing a powerful convergence, as the costs of launching new ventures and applying new technologies have dropped enormously, while the speed and scalability with which they can be brought to market have increased dramatically,” Giancarlo said. “The world is changing. Our parents’ financial markets are gone. The 21st century digital transformation is well underway, and the digital technology genie will not go back in the bottle.”

“In order for the CFTC to remain an effective regulator, it must keep pace with these changes or our regulations will become outdated and ineffective, he added.