Officials from the US Securities and Exchange Commission (SEC) have denied they are “setting up” the buy-side to take the blame should a liquidity event result in large investor losses.
A question from the floor at a recent London conference entitled SEC Regulation Outside the United States suggested “the music” coming out of the commission was that the buy-side would be held responsible by the SEC for any losses should bond markets experience a crash.
Paula Drake, associate director, chief counsel and chief ethics officer at the SEC’s office of compliance, inspections and examinations, said the US regulator was “quite worried about bonds, liquidity and leverage and how fulsome the disclosure is”. But she denied they were “setting up” the buy-side in this way.
Other comments implied that Asian asset managers should be wary that their investor disclosure around liquidity of bond holdings was up to date in particular.
“These are extraordinary events, and the market is changing,” said Dan Kahl, assistant director of the SEC’s investment management division. “So if you’re disclosure is what it was when QE 1, 2 and 5 were in effect [the earlier stages of US quantitative easing], may be you should think again.”
Drake conceded this was not easy when liquidity could change quickly in a matter of days or weeks. She suggested some managers might be worried that the SEC would regulate in the rear view mirror by ruling retroactively that managers had not warned investors of the risks, although she said she hoped that would not happen.
She said the priorities for managers should be platitudes that are always applicable, and she listed transparency, clarity, disclosure, product understanding and the right product for right person. Specifically, she argued that firms must have done analysis regarding the suitability of an investment, that disclosure is clear and transparent, and that an investor understands what is being bought.
Other SEC representatives suggested the securities regulator would make changes concerning the fiduciary responsibilities of investment managers around bond products.
These should be expected in the next year or two, said Jim Burns, deputy director in the SEC’s trading and market division, partly due to the fact that bond markets had fallen behind the level of scrutiny afforded to equity markets.
“Compared with the equity space, bonds are an industry that has been neglected for many years,” he said. “There’s an awful lot of thinking going on by the staff of the agency in this area.”
Burns suggested that observers would do well to watch where the SEC’s trading and market division was focusing its efforts in order to get an idea of where changes would come. He said the current focus of the division included best execution, trade transparency and risk entailed by electronic platforms.
Scott Friestad, associate director of enforcement at the SEC, also noted that the regulator now found it harder to pursue cases because of an increase in the number of rival civil and criminal agencies that were pursuing cases simultaneously with them.
He gave the example of the US attorney-general bringing a case against Barclays’ use of dark pools the week after the publication of Michael Lewis’ book Flash Boys, a best-selling account of how high-frequency traders may gain an unfair advantage by being able to ‘front-run’ other participants.
He contrasted this case with the “deliberate approach” of the SEC where “we don’t jump to conclusions.”
“One of the biggest challenges is that there are too many cooks in the kitchen,” Friestad said, noting that things had changed from 10 years ago, when it was quite common for the US justice department (DoJ) to work on a case with the SEC. (The DoJ can bring a criminal prosecution, but the SEC can’t.)
“To be blunt there’s not much we can do to avoid that,” he said. “We can’t tell state prosecutor to buzz off.”