April 3, 2013
We are one week away from an important date in Dodd-Frank implementation: the April 10 compliance date for Dodd-Frank swap reporting rules for end-users. This date represents the first major compliance date for the end-user community, a class of market participants that includes many who have not been regulated by the CFTC until now.
As we move one step closer to the full implementation of Dodd-Frank, I’m reminded of another important transition, one from over 220 years ago, the transition of this great nation from a colonial monarchy to a national democracy. At the dawn of the United States of America, the founding fathers set out ten principles, the "Bill of Rights" that would bind the new national democratic government. Similarly, today I am setting out ten principles to guide the Commission as we move into a new, more transparent Dodd-Frank regulatory regime. I believe these principles best protect our consumers and end-users who help move our economy forward—and let's keep in mind that these end-users were not the cause of the financial crisis that lead to financial reform. In fact, end-users were among the many victims of the crisis and much of Dodd-Frank was drafted with their interests in mind.
The futures and swaps markets wouldn't exist without end-users. The primary public benefit of derivatives markets is that they provide end-users risk management opportunities that, in turn, allow them to more easily fund operations and investments and thereby generate economic growth. The ability of end-users to fund their operations is directly related to the prices paid by consumers and the overall well-being of our economy; so protecting the end-users is akin to protecting the every-day consumer. The End-User Bill of Rights therefore focuses on what I believe should be the inalienable rights of end-users:
1. Right to reasonable Dodd-Frank implementation. Dodd-Frank needs to be implemented and needs to be implemented quickly, but that does not mean it should be done so harshly. Back in December 2012, I supported the Commission providing good faith forbearance relief for swap dealers (SDs) and major swap participants (MSPs) until July 31, 2013 (under certain circumstances) when trying in earnest to come into compliance with new CFTC Dodd-Frank rules. Consistent with that six month forbearance relief, I will not approve an action against end-users seeking to comply with CFTC Dodd-Frank rules in good faith, provided they act in ways consistent with a good faith intention to comply, until after October 31, 2013.
2. Right to legal certainty. The Commission and the Commission staff need to provide the market as much legal certainty as possible as we move through a challenging implementation period. End-users and other market participants should have little doubt as to the status of their activities and the Commission and staff should respond thoughtfully and diligently to requests for legal certainty. When an answer isn’t easy to provide, then the Commission or staff should be as transparent as possible with the public. The Commission or staff should strive to provide the market relief or clarity well in advance of a compliance date—last minute relief and clarification should be avoided. Finally, during this implementation of Dodd-Frank, I will not support an action against an end-user, exchange, or anyone else on an issue deserving clarity that is the subject of an outstanding request for interpretive guidance.
To provide a specific example of where the Commission could assist the end-user community with additional legal clarity, take the legal status of trade options. The Commission should tighten our guidance on commodity contracts with volumetric optionality, consistent with Commission precedent. At the same time, the Commission should focus on implementing Dodd-Frank for non-trade option swaps and broaden the trade option exemption in order to minimize any market disruptions in the trade options market. We should give end-users the opportunity to meet their statutory obligation to report trade options through an annual Form TO so that the Commission can monitor these markets for problems or evasion.
3. Right to compete in the markets. End-users should be able to hedge without getting mauled by cheetahs or crushed by Massive Passives. To protect end-users' right to compete in the markets, the Commission should start with two common sense rulemakings: First, we need high-frequency trader registration and conduct rules to prevent cheetahs from going feral. We should also provide the public market quality metrics designed to help end-users and other non-cheetahs from distinguishing between false cheetah liquidity and true liquidity. Second, we need caps on speculation so that the commodity markets return to their principal role as risk management markets for end-users. The commodity markets worked best when end-users were the predominant players. The Commission should move quickly on a new proposal on speculation limits by May 1.
4. Right to safe accounts. We need strong rules and rigorous auditing to ensure that futures commission merchants (FCMs) don't abuse their role as intermediaries while not imposing undue burdens on FCMs that provide end-users access to critical risk management markets (including a sensible compromise on residual interest). End-users should also have the right to choose between full segregation or to have their money at an FCM. If we require the availability of this option, the market will provide end-users better and more competitively-priced access to full segregation. Congress should also act to give end-users backstop protection through federally-mandated insurance.
5. Right to have confidence in the commodity markets. End-users should be confident that their intermediaries, FCMs and SDs in particular, are appropriately regulated and supervised. The Commission needs to establish rules that do this and ensure they are being enforced. The Commission needs bigger penalties to deter the abuses that threaten the health and stability of the markets. I have called for raising civil monetary penalty maximums to $10 million for entities and $1 million for individuals. The current $140,000 maximum civil monetary penalty is simply an inadequate deterrence for an agency tasked with, among other things, deterring manipulation and preventing systemic risk. Today’s regulatory infractions can spawn tomorrow’s financial meltdown and the Commission should be able to seek penalties to deter the malfeasance and negligence that can contribute to systemic problems.
6. Right to clear (or not to clear). The right to clear or not to clear should be protected for end-users. Central hedging units for non-financial end-users should be free to clear or not to clear on transactions that mitigate commercial risks for their corporate group. End-users that use inter-affiliate swaps to centralize and manage risk across a corporate group through a central hedging unit should be given the flexibility to clear or not to clear. End-users’ inter-affiliate swaps should also be exempt from transaction-by-transaction reporting. The Commission should move quickly to provide relief from reporting requirements for inter-affiliate transactions for end-users.
7. Right to margin flexibility and reasonable capital rules. Under-collateralization has not been an end-user problem. Accordingly, I support the latest February 2013 IOSCO/Basel consultation that would exempt non-financial entities that are not systemically important from prescriptive margin requirements. The Commission also needs to come up with a sensible compromise on capital requirements for non-financial SDs. The Commission should encourage non-financial SDs to register. Non-financial SDs provide competition to financial SDs and their presence lets end-users hedge their risks on more competitive terms. On the one hand, Commission capital rules should ensure non-financial SDs have adequate capital to fall back on in the event of market or portfolio stresses. On the other hand, these rules should not put non-financial SDs at a competitive disadvantage.
8. Right to hedge. Speculative position limits should encourage and not unduly complicate prudent commercial risk management practices. Public power end-users using swaps to hedge commercial risk should have the same access to risk management markets as privately-owned utilities. This should be done preferably through regulatory relief.
9. Right to smart regulation. As we move through implementation, we are going to find smarter ways to accomplish regulatory policy goals. The Commission owes the end-user community a commitment that it will amend its rules when these smarter ways become apparent. For example, there may be more prudent ways to implement Part 46 historical swaps reporting for end-users that the Commission should consider. In the interim, the Commission should give end-users a six month reprieve, through October 2013, for historical swaps reporting requirements.
10. Right to be heard. SDs and MSPs are, by definition, big boys and girls who’ve seen the writing on the wall for years. As Commission registrants and as large financial conglomerates, they can go to the NFA or industry organizations like ISDA for guidance on how to comply with our rules. NFA and ISDA and similar organizations have experience orchestrating change on an industry-wide basis. Many end-users, on the other hand, are not used to having their swaps activity subject to CFTC regulation. During and after Dodd-Frank implementation we need a venue for end-users to air their concerns. I call for an End-User Advisory Committee (EUAC) with regularized meetings. End-users face an array of unique compliance challenges and legitimate business and regulatory concerns that warrant the Commission’s focused attention.
Just like the Constitution is subject to amendment (some of the best amendments came almost eighty years after the first ratified draft), so is this document. I look forward to working with end-users, consumers, SDs, MSPs, FCMs, and others as we move through an exciting and challenging implementation period and invite their comments on this End-User Bill of Rights. If we do our jobs as regulators and implement Dodd-Frank quickly and reasonably, the markets will improve for the benefit of end-users and the American public. That was the goal of Congress and that continues to be my goal.
Last Updated: April 3, 2013