Trader Pay, Rater Rules, ‘Sinister’ Insurance, EU Auditors: Compliance

U.S. banks would have to change the way they compensate traders involved in market-making activities under one of the proposed restrictions of the so-called Volcker rule, according to a draft circulating among regulators.

The rule, which aims to ban most proprietary trading by banks with federally insured deposits, would exempt trades related to market-making as long as the activity met at least seven standards, or principles. One principle would be that traders get paid from fees and the spread of the transactions rather than the appreciation or profit from their positions, according to a copy of the draft reviewed by Bloomberg News.

The Volcker rule, part of the Dodd-Frank Act, is being written by regulators in five Washington agencies and may be released as early as October, according to three people briefed on the discussions. It aims to reduce the chance that banks will make risky investments with their own capital that put their deposits at risk.

Banks including JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) have shut down or made plans to spin off standalone proprietary-trading groups to prepare for the rule, which is named for its original champion, former Federal Reserve Chairman Paul Volcker.

Lawmakers who crafted Dodd-Frank in 2010 chose to exempt market-making from the rule, along with certain forms of hedging and underwriting, because of concerns that a broad ban on proprietary activities could bring some U.S. and world markets to a halt. The 174-page draft, dated Aug. 11, shows among other things how regulators including the Federal Reserve and Federal Deposit Insurance Corp. are working to define market-making.

The draft proposal may still change, the people briefed on it said. Each of the draft’s sections is followed by dozens of questions from regulators seeking more details as they prepare the final draft language.

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Compliance Policy

Small Credit Raters Say SEC Rule Gives Big Three an Advantage

Small credit-rating firms complain that proposed rules requiring analysts to do more training are too costly and would help larger firms without addressing the errors that contributed to the financial crisis.

Lawmakers have criticized credit-raters for contributing to the 2008 credit meltdown by inflating ratings on mortgage securities. Last year’s Dodd-Frank Act mandated reforms including reducing conflicts of interest, vetting assets more thoroughly and better analyst training and testing.

The Securities and Exchange Commission released 517 pages of proposed rules in May that would require credit-rating firms to keep marketing and ratings departments separate, conduct more due diligence on assets and establish a schedule for training and testing analysts.

Smaller firms say those rules hand an advantage to the three dominant players -- Standard & Poor’s Rating Services, Moody’s Investors Service Inc. and Fitch Ratings.

Sean Egan, president of the Egan-Jones Ratings Co. of Haverford, Pennsylvania, which has 22 employees, said in an interview that the proposed training and testing rules don’t address the fundamental conflict of interest at the heart of most credit raters’ business model: Raters are paid by the companies whose financial products they are rating.

An April congressional report noted the pressure placed on raters by banks that pay for the ratings.

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FSB Says Australia Should Speed Work on Bank Recovery Plans

The Financial Stability Board said Australia should speed work on “recovery and resolution plans” for big banks.

Plans should focus on banks’ critical economic functions, the FSB said yesterday in a “peer review” of Australia released by e-mail.

McCoy Says Mortgage Rules to Back Simplified Disclosures

The Consumer Financial Protection Bureau will begin writing mortgage rules next month that will back up its simplified loan disclosure forms, the agency’s top mortgage official said.

The consumer bureau will soon wrap up testing of two-page disclosure forms, after which the process for writing the underlying rules will begin, Pat McCoy, the agency’s assistant director for mortgage and home equity markets, said yesterday.

McCoy made the remarks at a Mortgage Bankers Association conference in Washington.

The bureau intends to publish proposed forms and regulations by July 21 of next year, McCoy said at the conference.

France Has No Plans to Recapitalize Banks, Minister Says

French Budget Minister Valerie Pecresse said that the government has no plans for a recapitalization of French banks and that the lenders are “solid” and don’t need more funds.

The government is “working hand in hand with the banks” and meets with the banks’ chiefs often, Pecresse said. The minister declined to confirm whether a meeting took place on Sept. 11 between the government and the heads of France’s five biggest banks regarding an investment plan, as reported Sept. 25 by Journal du Dimanche.

Pecresse spoke on the TV program Le Grand Jury on LCI.

Germany to Negotiate Tax Accord With Liechtenstein, Focus Says

Germany will start negotiations with Liechtenstein for an agreement to address tax evasion, Focus reported, citing Deputy Finance Minister Bernhard Beus.

The government aims to reach an agreement similar to the one concluded with Switzerland, the magazine said in a preview of an article to appear in its next edition.

Europe to Propose Tougher Rules for Auditing Firms in November

The European Commission, the European Union’s executive arm, will propose new rules for auditors in November to bolster investor confidence in financial information.

The measures could force companies to periodically change auditors and prevent auditing firms from offering management- consulting services, Accountancy Age reported yesterday, citing a draft version of the proposals.

Commission officials have yet to complete the draft measures, which “may be subject to change before they’re proposed in November,” Chantal Hughes, a spokeswoman for the commission, said in a telephone interview in Brussels.

The EU began reviewing audit rules last year. The top four accounting firms have market share of about 90 percent in the majority of EU member states, according to the commission’s report last year.

EU Seeks to Resolve U.K.-ECB Clash on Derivatives Clearing

Derivatives clearinghouses such as LCH.Clearnet Group Ltd. may face less pressure to move parts of their business from the U.K. to the euro area as European Union negotiators seek to resolve a clash between Britain and the European Central Bank.

Poland, which holds the EU’s rotating presidency, proposed changing a draft law on over-the-counter derivatives so that “no member state or a group of member states should be discriminated, directly or indirectly, as a venue for clearing services,” according to the document posted on an EU website. The U.K. said “there are a number of issues” requiring discussion before Britain can sign off on the law.

The new wording was added to negotiating texts after the U.K. said on Sept. 15 that it would sue the ECB over its plans to prevent some euro-denominated securities from being cleared outside the 17 countries that share the currency. The text was added to ease U.K concerns that the ECB may push for clearinghouses to relocate, according to an EU official familiar with the talks who couldn’t be identified because negotiations on the measures are private.

EU governments have discussed giving clearinghouses access to central-bank liquidity as a way to prevent them from collapsing and causing a financial crisis. The ECB has said clearing activities should take place in the euro region if it is expected to provide such financial support.

The U.K. has argued that the ECB’s position violates EU principles that guarantee companies freedom to choose where they do business within the bloc’s borders.

The derivatives rules are scheduled to be discussed at a meeting of EU diplomats on Sept. 29, according to the EU official.

Compliance Action

SEC Drops Claims Against Ex-Officer of Alabama County

The U.S. Securities and Exchange Commission said it voluntarily dismissed claims against the former president of the Jefferson County Commission in Alabama, Larry Langford.

The SEC dropped claims against Langford after he received a 15-year prison sentence and restitution and forfeiture orders in a parallel criminal case that arose from the SEC investigation, according to a statement on the agency’s website.

The criminal case is U.S. v. Langford, 7:08-cr-00245, U.S. District Court, Northern District of Alabama (Birmingham). The appeal in the criminal case is U.S. v. Langford, 10-11076, U.S. Court of Appeals for the 11th Circuit (Atlanta).

Finland Banks Must Brace for Longer Debt Crisis, Watchdog Says

Finland’s financial institutions must take steps to protect themselves from a protracted debt crisis, the country’s financial watchdog said.

Banks operating in Finland, including Nordea Bank AB (NDA) and Sampo Bank, a unit of Danske Bank A/S, face “significantly increased” risks from the debt crisis that threatens the financial system of the euro area, the Financial Supervisory Authority said in a report published today in Helsinki.

The country’s lenders had a capital adequacy ratio of 14.4 percent and the aggregated core Tier 1 ratio was 13.2 percent on June 30, the financial supervisor said. Banks’ deposit stock has risen by 3 billion euros ($4.1 billion) this year, strengthening funding structures, the watchdog said.

Sweden Insurers Should Review Finances, Watchdog Says

Swedish insurers should review their ability to strengthen finances if needed and make sure their long-term commitments to customers are sustainable, the Swedish Financial Supervisory Authority said in a letter posted on its website today.

The financial watchdog said it’s worried market uncertainties will prompt insurance companies to sell stocks and buy bonds, which could worsen the situation for insurers that are finding it difficult to stay solvent.

Courts

Insurers Can Contest Stranger-Originated Policies, Court Rules

Insurers can challenge life policies that pay investors when the subject of the policy dies, the Delaware Supreme Court ruled, citing state policy, as well as 18th-century British law.

The federal court in Wilmington had asked the state high court to interpret Delaware law on the question of honoring such policies, according to two opinions filed Sept. 20. The insurers said such so-called stranger-originated life insurance policies were invalid because the beneficiaries were part of a “multi- layered trust scheme” in which investors paid the premiums.

“Under Delaware common law, if a life insurance policy lacks an insurable interest at the inception” it is void, even after a two-year contestability period, because it violates state policy against wagering, the justices decided.

The decision arose from two cases filed since 2009 in federal court, one from Lincoln National Life Insurance Co. and the other from PHL Variable Insurance Co. (Phoenix), according to court papers. In each case, the insured has died.

The court noted that the use of so-called dead pools to wager on strangers’ lives was a popular practice in England until it was prohibited in 1774. In 1881, the U.S. Supreme Court described such wagers as a “sinister” interest in seeing the insured die, according to the Delaware decision.

The two lawsuits filed by the insurers are continuing in federal court in Wilmington.

The cases are Variable Insurance v. Price Dawe Insurance Trust, 10-CV-964; and Lincoln National v. Joseph Schlanger 2006 Insurance Trust, 09-CV-506, U.S. District Court, District of Delaware (Wilmington).

Interviews/Speeches

Carney Says Delaying Financial Regulations Won’t Aid Recovery

Bank of Canada Governor Mark Carney told a banking group that new financial-market regulations won’t hobble the global economic recovery, citing the recent UBS AG (UBSN) trading loss of $2.3 billion as an example of why greater controls are needed.

The Basel III regulations, which need to be implemented by 2019, give countries with weaker economies time for a smooth transition, Carney, 46, said in the text of a speech he was set to give yesterday to the Institute of International Finance in Washington. The IIF’s research overstated the potential losses to output from the new rules, he said.

“The implementation timetable for Basel III begins in two years and ends in 2019,” Carney said in the speech. “It is difficult to believe that prolonging this implementation phase even further would have a material impact on real economic outcomes.”

Carney said that historically well-capitalized banks have been rewarded with better valuations.

“In the end, it is in your interest to comply,” Carney said. Arguments that companies will seek to bend the rules or that financial crises can’t be avoided is a “fatalism” that “should be rejected,” he said.

Comings and Goings

UBS Bankers Face Few Options as Securities Unit Shrinks

As UBS AG (UBS) prepares to shrink its investment bank following a $2.3 billion loss from unauthorized trading, bankers pushed out or looking to leave may find few opportunities as Wall Street rivals slash jobs.

Switzerland’s biggest bank said on Sept. 24 that its investment bank will carry less risk and use less capital in the future, after the loss by a trader on the Delta One desk in London spurred demands to scale back the division.

Even before the trading scandal, Zurich-based UBS had announced plans to cut 3,500 jobs, with 45 percent of those reductions at the investment bank, as market turmoil curbed client activity and rising capital costs made certain businesses less attractive. The firm now may accelerate that shrinkage, throwing more bankers out of work at a time when European rivals including HSBC Holdings Plc (HSBA), Barclays Plc and Credit Suisse Group AG (CSGN) have announced plans for more than 70,000 cuts.

The biggest global banks are trimming jobs the fastest since 2008 as companies seek to improve profitability, regulators boost capital requirements and a weakening economy squeezes revenue.

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To contact the reporter on this story: Carla Main in New Jersey at cmain2@bloomberg.net.

To contact the editor responsible for this report: Michael Hytha at mhytha@bloomberg.net.

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