skip to main |
skip to sidebar
This afternoon, the SEC and CFTC factions settled their feud over derivatives regulation. The "concept paper" developed jointly by Barney Frank and Collin Peterson would divide regulation "depending on the underlying asset" between "either the SEC or the CFTC, or potentially both."
Playing Solomon over this arrangement would be the still-non-existent Financial Services Oversight Council which will have 180 days to "resolve disputes ... over new products."
How could this not work?
For a summary see this Reuters Fact Box.
In virtually every other country in the world, financial statements are prepared according to the International Financial Reporting Standards (IFRS) set by the London-based International Accounting Standards Board (IASB). The IFRS is, if you will, the metric system of accounting.
In mid-July, the IASB proposed a simple new way of apportioning financial instrument valuation methods. The new standard establishes only two security catergories: loans, and instruments that act like loans (valued at cost), and everything else (marked to the market) The Economist called the compromise “a superior sort of fudge.”
We should probably be paying attention to what IASB does because, at least pre-crisis, everyone agreed that their system should replace GAAP. Canada shed GAAP last year and in February the SEC announced a framework (which they called a “road map” – release no. 33-8982) for full IFRS adoption in the United States by 2014.
FASB and the IASB have been working on joint projects since at least 2002 and in October they created a joint Financial Crisis Advisory Group.
If you’d like to get a jump on the IFRS-ification of US accounting (never too early!) this AICPA website has a guide to IFRS and the creepily-named “convergence” of GAAP and IFRS. If you’d like a head-to-head comparison, Warren Gorham & Lamont’s treatise International Accounting, Financial Reporting, and Analysis is available on Westlaw (WGL-INTLACCT).
Over the course of the last week, Treasury has become a virtual proposed-legislation factory – cranking out a new draft bill every few days. I haven’t spent a lot of time processing this legislative incontinence because their previous attempt at legislation-proposing, the Resolution Authority for Systemically Significant Financial Companies Act of 2009, sank without a trace. Treasury and the White House agree on what regulatory reforms we need, but standing between them is Congress. Without a congressional sponsor, Treasury’s reform agenda can’t move forward.
Prospects look brighter for the current crop of proposals. Of the four, two have already made the leap from suggestion to proposed legislation. The difference appears to be Barney Frank. Frank’s sponsorship transformed the Consumer Financial Protection Agency Act of 2009 into HR 3126. Frank has also elevated the administration’s say-on-pay proposal to bill status (HR 3269). Both bills have been referred to the House Committee on Financial Services, which Frank chairs. Rumor has it that Frank also doomed the resolution authority bill when he changed his mind about giving it support. Now that he’s on board, I assume we can expect the Private Fund Investment Advisers Registration Act of 2009 and the as-yet-unnamed credit rating agency bill to move forward, too.
A few days ago, the investigative panel was finalized for the bipartisan committee charged with investigating the causes of the financial collapse. Expectations are high. The new panel has already been compared to the Senate subcommittee that investigated the 1929 crash. That celebrated investigative body, known as the Pecora Committee after its magnetic investigating attorney, exposed all kinds of legal, but damned sneaky, goings-on and gettings-up-to on Wall Street.
Is our new commission, composed mainly of politicians and chaired by *choke* the former Treasurer of California (Phil Angelides), up to the job? Can a panel with only two people who know anything about derivatives (Brooksley Born and Heather Murren) really untangle what happened to AIG? Can a committee that features Bill Thomas twice voted meanest Senator in Washington ever agree on anything?
The answer, in my opinion, is that it doesn't matter. The much-lauded Pecora Committee wasn't a serious investigation - it was a circus (complete with little people). It was representative democrary in action: the subcommittee, chaired by a guy who was born in a "dug out" in the Dakota Territory, allowed representative ordinary people a forum to humiliate Wall Street bankers.
The '33 Act and the '34 Act were written by legal scholars, but the scholars got the opportuntity to write the law they wanted because the Pecora Committee kept Wall Street notorious. A string of headlines about bank presidents not paying taxes, or giving out plum stock offerings for free to their pals, kept people mad enough to support the strong regulation that resulted.
We need better reform than has been proposed by the administration. The new commission can help us get there by keeping up the parade of shifty bankers and little old ladies who've lost everything.
Matt Taibbi’s article about Goldman Sachs is a refreshing return to form for Rolling Stone, the magazine that was once home to Hunter S. Thompson. Gonzo journalism, a term coined by Thompson when he worked for Rolling Stone, is a journalistic form that puts a cantankerous writer and his sainted opinions right at the center of the story. If you ask me, the way we talk about the financial crisis could benefit from this kind of humanizing touch. Taibbi is pissed off. Aren’t you?
Since the article came out, Taibbi has spent much of his time defending himself. He’s been called sloppy (Business Insider), dumb (Megan McCardle), and intemperate (Felix Salmon to be fair, Salmon likes the article).
His critics are at a disadvantage – Taibbi is cooler than they are and he writes better. Megan McCardle takes an unfortunate stab at sounding hep and titles her article “Matt Taibbi Gets His Sarah Palin On.“ The Business Insider is shocked to find it isn’t reading the Economist: “The story is really not meant,” they sniff, “for an audience interested in a discussion of financial markets, as evidenced by his rhetorical style.” I laugh every time I read that.
As an expansion on yesterday's discussion of SEC accounting and FASB, I offer a quick research guide to GAAP materials for public companies.
Because of the variety of sources, I have found it useful to start with an accounting treatise. There are two Warren Gorham & Lamont treatises on Westlaw that cover accounting for public companies. Both treatises discuss the entire GAAP hierarchy from Regulation S-X to the FASB Emerging Issues Task Force. The SEC Accounting and Reporting Manual (WGL-SECMAN) is organized by disclosure type. There are sections on registering securities and filling out form 10-K. The Handbook of SEC Accounting and Disclosure (WGL-SECHDBK), on the other hand, is organized, like a convential auditors handbook, by financial statement type (the first chapter is "Balance Sheets.")
Reasearching primary FASB materials is about to change dramatically. In June, FASB published SFAS No. 168: The FASB Accounting Standards Codification (FASB ASC). The FASB ASC, which comes into force in the third quarter of this year, replaces pretty much every existing GAAP document and flattens the GAAP hierarchy to two levels (in FASB ASC, and not). Basic level access to a database containing FASB ASC is free.
GAAP stands for "Generally Accepted Accounting Principles." The loose, easy sound of this belies the fact that GAAP is mandatory. The Code of Conduct of the American Institute of Certified Public Accountants forbids accountants from departing from "principles promulgated by a body designated by the AICPA Council to establish such principles." The AICPA's promulgator of principles is the Financial Accounting Standards Board (FASB) an accounting think tank organized in 1973. FASB, based in Norwalk, Connecticut, is controlled by a trust called the Financial Accounting Foundation.
GAAP isn't one document - it is a dizzying array of more than 2000 accounting "pronouncements" issued by a variety of authorities. The pronouncements are arranged in a strict hierarchy laid out in FASB Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles. At the top of the heap are FASB's Statements of Financial Accounting Standards (SFAS).
The securities laws (e.g. '33 Act sections 7 & 19(a)) give the SEC control over accounting standards for public companies, but the SEC has always delegated this power to private organizations. Upon FASB's organization the SEC transferred to it power to set accounting standards. Before the organization of FASB, the AICPA had SEC approval to set standards (thus, AICPA "Accounting Principles Board Opinions" from before 1973 carry the same weight as SFAS). The SEC also describes FASB pronouncements as "generally accepted," but to the SEC the phrase has a very different meaning - the SEC is indicating that it has provisionally agreed to use FASB standards, but reserves the right to set them aside. In the words of the SEC, they are "recognized as authoritative in absence of any contrary determination by the Commission."
The SEC's control over public company accounting standards was recently reinforced by the Sarbanes-Oxley Act which required reaffirmation that FASB was sufficiently independent to act as the financial accounting designee of choice (release no 33-8221).
Speculation has moved to the front of the agenda at the Commodity Futures Trading Commission. The CFTC has embarked on two regulatory excursions that will examine areas where speculation has been overlooked, or even sanctioned.
The Commodity Exchange Act is an anti-speculation law. Section 4a(a) declares that excessive speculation in commodity futures may "cause sudden or unreasonable fluctuations" in the prices of the underlying commodities. The CEA gives the CFTC express power to control speculation. The CFTC has enacted rules controlling speculation in agricultural commodity futures (see this CFTC guide) but not in futures for other commodities. Yesterday, the CFTC announced that it would begin hearings on the possiblity of controlling speculation in energy commodities by developing similar position limits for those futures. According to Bloomberg News, this may mean trouble for the energy trading departments at Goldman Sachs and Morgan Stanley.
Bona fide hedging transactions, "economically appropriate to the reduction of risk," are exempt from the agricultural commodity position limits. In March, the CFTC issued a concept release announcing plans to review the way bona fide hedging exemptions are granted. For more on that release see this Fried Frank memo.
Yesterday, Thomson Reuters released a report on global M&A activity since the beginning of the year. Most of the numbers were predictably gloomy: global M&A is down 40% and US M&A is down nearly 50%. In Canada, on the other hand, M&A is up 25% from last year. Pretty much the entire increase can be accounted for by the merger of Petro-Canada and Suncor. This $20 billion deal made up nearly 30% of 2009's Canadian M&A of $61 billion, but that still means Canadian M&A is flat while the rest of the world is off 40%.
My sources in Canada tell me that the M&A boom has been fueled (sorry) by a scramble to grab Canada's natural resources. The numbers bear this out. A search of the M&A database in Westlaw Business found 88 deals announced since the beginning of the year where a Canadian company was the target. 36 of those 88 were acquisitions of mining or oil & gas companies.
In 16 of those 36 deals, the acquiror was a non-Canadian entity. It has been reported that the Chinese government is implementing a "go abroad" investment strategy and in the last few days, they appear to have taken a special interest in Canada. On June 29th the Swiss-Canadian oil company Addax was acquired by Sinopec for a 47% premium over its share price. Denison Mines, meanwhile, has been fighting off rumors that it sold a control stake to Sinosteel and today CIC, the Chinese sovereign wealth fund, announced it was buying 17% of Teck Resources.
In previous posts, I've talked about derivatives in general terms, but today I'd like to focus on the most widely used type of derivative - the swap. I'm going to use the example of a simple interest rate swap in a single currency (although, be warned - there are no simple swaps). For purposes of this discussion, let's pretend it is January of 2008 and you are the CFO of a medium-sized company.
You need to borrow $20 million from the bank. Your banker offers you a very good, fixed interest rate of 3.5% (50 basis points less than the current LIBOR rate of 4%) and you say yes. Your monthly interest payment is $70,000. Because you are a saavy user of the credit markets, you decide to enter into an interest rate swap to hedge your exposure in the event interest rates fall.
An interest rate swap is a fake transaction where two parties pretend to borrow money from each other. The only thing that prevents the transactions from being a wash is that one phony borrowing is at a fixed rate and the other is at a floating rate. The amount of the phony loan is called the "notional amount." Once a month, you and the other party get together and compare interest rate payments. The party with the higher payment turns over the difference.
Your swap is structured like this - you "borrow" $20 million from a third party (let's call them "Wasp") at the LIBOR rate and Wasp "borrows" $20 million from you at 3%. Therefore, Wasp's payment to you will always be $60,000, but your payment to WASP will vary with the LIBOR rate. At your initial settlement, you owe Wasp money. Your imaginary LIBOR-pegged payment would be $80,000. $80,000 minus Wasp's pretend payment of $60,000 = $20,000. You pay Wasp $20,000. In total, you end up handing over (to Wasp and the bank) $90,000. Not such a good deal for you, yet.
Then, the credit markets collapse and interest rates go down with them. Your 3.5% loan becomes a bad bargain, but your interest rate swap begins to bear fruit. At your next settlement, your LIBOR-pegged payment is down to 2% so Wasp owes you $40,000. If you apply this money to your bank loan, your reduce your interest payment to $30,000.
See how simple that is?
FASB has also been very busy of late. While I was on vacation, they released FAS 166 and 167 about accounting for off balance-sheet entities (more from FEI Blog) and today they began a five-city "listening tour." Presumably, this means they won't talk? The listening tour is Hillary Clinton's invention. Is FASB going to run for the Senate?
It has been a big day. Yikes. Adding to the big-ness: the administration sent to the Hill the proposed text for a law creating the Consumer Protection Agency. This brand-new agency would wield tremendously broad power. A look at the definitions section of the 150-page bill uncovers a definition for consumer: "an individual." Also "defined," is "consumer financial product or service." Guess what that means - "a financial product or service used by a consumer."
Since writing about resolution authority for WB, I have followed with interest the continued unraveling of Northern Rock which the UK government nationalized back in 2008. Today, FT Alphaville reports that NR's financial health has declined to the point that it can't meet its capital adequacy requirements. So, HM Treasury is planning to split it into two pieces. Northern Rock Bank Co will be the deposit-taking (healthy) bank and all the toxic (or "legacy") assets will be transferred to Northern Rock Asset Co.
Is this the kind of disaster we can expect if the administration gets the power to resolve failing financial institutiuons?
JD Supra has a new memo from Edwards Angell Palmer & Dodge about the SEC's proposed revivification of surprise raids on brokers who have custody of client assets. This should be some comfort to John Coffee who recently laid blame for the longevity of the Madoff fraud on the rule that allows broker-dealers to have custody of assets.
Apparently, there was much excitement at today's SEC open meeting. Compliance Week reports that the Commission voted to approve the NYSE's proposed ban on discretionary voting by brokers (see this post for more on discretionary voting). The vote was 3-2 along party lines.
FT Alphaville notes that the Commission also agreed to institute a say-on-pay requirement for TARP-recipient institutions.
