July 12, 2013
I want to call to order and welcome everyone to this public meeting of the Commodity Futures Trading Commission – our 30th such public meeting to consider adopting measures to implement the swaps reforms of the Dodd-Frank Wall Street Reform and Consumer Protection Act. I want to thank my fellow Commissioners, Bart Chilton, Scott O’Malia, and Mark Wetjen, for their efforts and contributions in working on and reviewing the documents we will consider today. And I also want to recognize the efforts and contributions of Commissioner Jill Somers who, though no longer with the Commission as of this past Monday, has played such a significant role in the Commission’s Dodd-Frank swap reform efforts over the past several years. Finally, I want to express my thanks and appreciation to the Commission staff that has devoted their efforts, long hours, holidays, and weekends, towards preparing the documents the Commission will consider at this public meeting.
I support the Interpretive Guidance and Policy Statement Regarding Compliance with Certain Swap Regulations (Guidance) and the related phase-in exemptive order also being adopted today. With this Commission action another important step has been taken to make swaps market reform a reality.
This Guidance is being adopted just shy of the third anniversary of President Obama signing the Dodd-Frank Act, and that law was historic. It was an historic answer to an historic problem: the near collapse of the American economy driven, in part, by the unregulated derivatives marketplace. Congress and the President were clear in their intention to bring transparency to this marketplace, to lower risk to the public, and to ensure the regulation of swap dealers and major swap participants.
In 2008, when both the financial system and the financial regulatory system failed the public, Americans paid the price through the crisis with their jobs, their pensions, and their homes. We lost 8 million jobs in that crisis and thousands of businesses shuttered. The swaps market was central to the crisis and financial institutions operating complicated swaps businesses and offshore entities nearly toppled the economy. Congress responded. Americans are remarkably resilient – but the public really does expect us to learn from the lessons of the crisis, and to do everything possible to prevent this from happening to any of us again.
It's pretty straightforward, I think. Even though we oversee, here at the CFTC, a complex and sometimes difficult to understand market (my mom consistently asks me, “Gary, what are swaps?”), the questions the American people are looking for us to answer are simple: Have we lowered risk? Have we brought transparency to these markets? Have we promoted competition and openness in these markets so that end users can get the greatest benefit when they seek to lower their risk and focus on what they do well – which is employing people, innovating and moving our economy forward? That is why reform matters.
Five years after the crisis and three years after Dodd-Frank passed, market participants are coming into compliance with the common sense reforms that Congress and the President laid out. Through Dodd-Frank and the rules that this agency has put in place, no longer will the markets be opaque and dark, and we will have transparency in the markets. In fact, throughout this year, for the first time, the public and regulators have benefitted from reporting to swap data repositories and reporting to the public. And later this year, starting actually in August, facilities called swap execution facilities will start so that the public can benefit from greater openness and competition before the transaction occurs. And by the end of this year, there are likely to be trade execution mandates for interest rate and credit derivative index products, as well.
Central clearing became required for the broader market earlier this year, with key phase in dates to come this Fall and Winter, as well. We have 80 swap dealers, and, yes, two major swap participants, now provisionally registered. As part of the responsibilities accompanying registration, they're responsible for sales practice, record keeping and other business conduct requirements that help lower the risk to the public.
Yesterday, we took another significant step when we and the European Commission announced a path forward regarding joint understandings regarding the regulation of cross border derivatives. I want to publicly thank Commissioner Michel Barnier, his Director General Jonathan Faull, and their staffs, the staffs at the European Securities Market Authority, and Steven Maijoor’s leadership, for collaborating throughout the reform process. This was a significant step forward in harmonizing and giving clarity to the markets as to when there might be jurisdictional overlaps with regard to this reform.
Today, we are considering two important actions, the Guidance, as well as a related phase-in exemptive order. And as you probably have heard me say before, the nature of modern finance is that financial institutions commonly set up hundreds, even thousands of legal entities around the globe. In fact, the U.S.'s largest banks each have somewhere between 2,000 and 3,000 legal entities around the globe. Some of them have hundreds of legal entities just in the Cayman Islands alone. We have to remind ourselves that the largest banks and institutions are global in nature, and when a run starts on any part of an overseas affiliate or branch of a modern financial institution, risk comes crashing right back to our shores.
Similarly, if it's an EU financial institution and it has some guaranteed affiliate in the U.S. or overseas that gets into trouble, that risk can flow back to their shores. That's why, together both we and Europe recognize the importance of covering guaranteed affiliates, whether they're guaranteed affiliates of a U.S. person or of an EU person.
There's no question to me, at least, that the words of Dodd-Frank addressed this (i.e., risk importation) when they said that a direct and significant connection with activities and/or effect on commerce in the United States covers these risks that may come back to us.
I want to publicly thank Chairman Barney Frank along with Spencer Bachus, Frank Lucas, and Collin Peterson, and their staffs for reaching out to the CFTC and he public to ask how to best address offshore risks that could wash back to our economy in Dodd-Frank.
In addition, we should not forget the actual events over the past several years that remind us of the risks to the U.S. that can be posed by offshore entities:
AIG nearly brought down the U.S. economy. Lehman Brothers had 3,300 legal entities, including a London affiliate that was guaranteed here in the U.S., and it had130,000 outstanding swap transactions. Citigroup had structured investment vehicles that were set up in the Cayman Islands, run out of London, and yet were central to not one, but two bailouts of that institution. Bear Stearns, in 2007 had two sinking hedge funds that had to be bailed out by Bear Stearns – and, yes, those hedge funds were organized in the jurisdiction of the Cayman Islands.
More than a decade earlier, I was working in my position as Assistant Secretary of the United States Department of the Treasury. I found myself making a call from Connecticut to then Treasury Secretary Robert Rubin to report that Long Term Capital Management’s $1.2 trillion swaps book was not only going to go down within a day or two, but that the business – that we thought was in Connecticut – was actually incorporated in the Cayman Islands as a PO Box facility.
Even last year, we had yet another reminder that branches of big U.S. banks can bring risk back to the US. Even though they were not the risks as large as I've just related, JPMorgan Chase's Chief Investment Office’s credit default swaps were executed primarily in the U.K. branch.
Each of these examples demonstrated a direct and significant connection with activities and/or an effect on commerce in the United States. Congress knew this painful history when it provided the cross border provisions of swaps market reform. And as market participants asked the CFTC to provide interpretive guidance on Congress's word, I believe that we have had to keep this painful history in mind. Two and a half years ago, the CFTC started working on guidance, which was published for notice and comment in June 2012, and for which we sought further input on in December 2012. We have greatly benefitted from this public input. The Guidance the Commission will adopt today incorporates the public’s input and, I think, appropriately interprets the cross border provisions of Dodd-Frank.
There are four areas that I think really are important:
First, The CFTC interprets the cross-border provisions to cover swaps between non U.S. swap dealers and guaranteed affiliates of U.S. Persons, as well as swaps between two guaranteed affiliates that are not swap dealers. The guidance does, as was proposed, recognize and embrace the concept of substituted compliance where there are comparable and comprehensive rules abroad. But the history of AIG, Lehman Brothers, Citigroup and the others, and of guaranteed affiliates, is a strong lesson that Congress knew when we were approaching these issues.
Second, the definition of U.S. person in this guidance captures offshore hedge funds and collective investment vehicles that have their principal place of business here in the U.S., or that are majority owned by U.S. persons. Addressing ourselves to guidance, and yet forgetting the lessons of Long Term Capital Management of Bear Stearns, is not in my opinion what Congress wanted.
Third, under the guidance, foreign branches, like the JPMorgan's U.K. branch, of U.S. swap dealers may also comply with Dodd-Frank through substituted compliance if they are appropriately ring – that is, they are truly branches where employees and the booking and the taxes are actually offshore in the foreign branch. The Guidance allows, if there are comparable and comprehensive regimes overseas and supervisory authorities overseas looking at those branches, that those branches can avail themselves to substituted compliance in the manner as offshore guaranteed affiliates would.
Lastly, the guidance provides that swap dealers, foreign or U.S., transacting with U.S. persons (whether they be in New Jersey, Maryland, Michigan, Arkansas, Iowa – I have to get all the right states, recognizing where my fellow Commissioners come from) anywhere in the United States, must comply with Dodd-Frank's swap market reform. The guidance does provide, though, that U.S. Persons can meet international people anonymously, and not only on our exchanges called designated contract markets, but also on the new swap execution facilities, as well as foreign boards of trade. International parties trading on those platforms do not have to worry about whether those swaps might make them a swap dealer, or whether they need to worry about certain transaction level requirements. And I think that was important to maintain and promote the liquidity of these three very important types of platforms – foreign boards of trade, swap execution facilities, and designated contract markets.
In conclusion, I will be voting in support of the Guidance and the related phase-in exemptive order also being adopted today. I'll say more about the exemptive order in my statement of support for that document, but I think these are both critical steps for the Commission and swaps reform. They add to the approximately 56 final guidance and rules that this Commission has adopted. We're well over 90 percent through the various rule and guidance writing. And the markets are probably well towards half way implementing these reforms. I have a deep respect for how much work market participants are doing to come into compliance.
So now, 3-years after the passage of financial reform, and a full year after the Commission proposed guidance with regard to the cross border application of reform, it is time for reforms to properly apply to and cover those activities that, as identified by Congress in section 722(d) of the Dodd-Frank Act, have “a direct and significant connection with activities in, or effect on, commerce of the United States.” With the additional transitional phase in period provided by this Order, it is now time for the public to get the full benefit of the transparency and the measures to reduce risk included in Dodd Frank reforms.
Last Updated: July 15, 2013