July 19, 2011
Consideration of Proposed Rules: Customer Clearing Documentation, Timing of Acceptance for Clearing and Clearing Member Risk Management
Consideration of Final Rules: Process for Review of Swaps for Mandatory Clearing; Part 40, Provisions Common to Registered Entities; and Removing Any Referance to or Reliance on Credit Ratings in Commission Regulations, Proposing Alternatives to the Use of Credit Ratings
Today, the Commission will consider three final rules and two proposed rules. I support the final rules as they are noncontroversial process rules. However, I have serious concerns with both proposed rules as they rely on weak statutory authority, poorly articulate a necessity for either rule and are neither justified nor required under the Dodd-Frank Act. Today’s draft rules regarding client documentation and clearing member risk standards were never mentioned previously during these months of intense rulemaking and seem to be fabricated from whole cloth. This is unacceptable.
I have grown increasingly frustrated with the rulemaking process because there appears to be no specific plan or strategy for implementing these rules, nor do we appear to be following President Obama’s direction to ensure that the federal rulemaking process be done in the most transparent, responsible and accountable fashion.
I have requested specific reforms to improve the rulemaking process, but each request has been met with silence. I fear that we are running astray of the President’s executive orders by eschewing transparency and accountability in favor of opacity and expediency. As we push forward, we are running out of time to make a correction. To be clear, the failure to produce a final rule schedule and implementation plan the next time the Commission meets on August 4th will render public input irrelevant as the Commission barrels through with final rules this fall.
Creating a More Open Government
In his inaugural address, President Obama gave us the directive; he told us to enter a new era of responsibility. To those of us who manage the public’s dollars, President Obama warned that we will be held accountable. Through spending wisely, reforming bad habits, and doing our business in the light of day, the President said that we can restore the trust between the American people and their government. Two days later, the President issued a memorandum to the heads of the Executive Departments and Agencies titled “Transparency in Open Government” in which he further laid out his implementation plan for an administration committed to creating an unprecedented level of openness in government.1 This plan offers the public increased opportunities to participate in policymaking and to provide the benefits of their expertise. It is about utilizing technology to communicate, collaborate, and improve opportunities to make the entire process more efficient and effective.
Executive Order #13,563 – Improving Regulation and Regulatory Review
This past January, President Obama grabbed our attention with a Wall Street Journal opinion piece2 to accompany his signing of Executive Order 13,563 “Improving Regulation and Regulatory Review.”3 He put the administration on this mission: “[T]o root out regulations that conflict, that are not worth the cost, or that are just plain dumb.” Yes, he did say that.
Executive Order #13,579 – Application to Independent Agencies
Six months later, the President signed another Executive Order (Executive Order 13,579) titled “Regulation and Independent Regulatory Agencies.”4 If the January directive wasn’t clear, this new order should eliminate any doubt that Independent Agencies like the CFTC must go out of their way to ensure responsible rulemaking by, among other things, undertaking a thorough cost benefit analysis, both qualitatively and quantitatively, to ensure that new rules do not impose unreasonable costs. We also must make our process more accountable through increased transparency and openness, which our current process lacks.
Reforms to Our Rulemaking Process
In an effort to respond to the concerns of the many citizens who have walked through my door and submitted comment after comment in the more than fifty rulemakings to date, I have put forward two proposals to squarely address the need for greater openness, transparency and accountability.
First, I have called for a detailed plan that reveals the order, timing, and substance of the Commission’s rules implementing and effectuating the Dodd-Frank Act. This proposal should have the benefit of public comment as well.
Second, I have requested that all proposed and final rules that the Commission will be voting on be published for seven-days prior to each public meeting. Today, the public must wait days, if not weeks for the Federal Register to publish proposed and final rules that the Commission has already voted on. My proposal will give the public a clear picture of the end result of the rulemaking process prior to our final vote.
The Commission has responded with silence, cementing in my mind that the current process is inadequate.
The Commission is tentatively scheduled to next meet on August 4th. I ask again that we make the final rule proposals publicly available seven days prior to that meeting. At that meeting, I propose that we first and foremost vote to put forward a clear rulemaking order and implementation schedule for public comment. This will allow the public to comment on the draft schedule during August before too many more final rules are passed this fall. If we continue to delay development of an implementation schedule and continue to adopt rules without the benefit of meaningful final comment, then we are being downright insubordinate. To ignore our President not once, but twice, and to respond to Congressional recommendations such as the letter we received Thursday, July 14th from Chairman Lucas and Subcommittee Chairman Conaway, which again implored us to adhere to what amounts to notions of honest dealing and fair play and to not make speed more important than substance, is arrogant and shameful. We can do better, and we should.
The Rules Before Us
The Removal of References to Credit Rating Agencies
I’d like to recognize Ward Griffin and his team for their work on the final rule before us regarding the removal of references to credit rating agencies from the Commission’s regulations.
Part 40 Rule Certification
I commend Bella Rosenberg, and her team for their work on this rule that provides an improved process for the evaluation of designated contract markets (DCMs), swap execution facilities (SEFs) and swap data repositories (SDRs) against the core principles outlined in the Commodity Exchange Act (CEA). The team has given thoughtful consideration to comments from both the public and from my office, and I believe their willingness to hear concerns and seek practical solutions that work has resulted in a final rule that is an improvement from the rule proposal.
Part 39 Process for Review of Swaps for Mandatory Clearing
I also commend Eileen Donovan and her team on their work to establish a new process for reviewing swaps for mandatory clearing. I support the final regulation today, because the regulation sets forth a reasonable process for a clearing organization: (1) to request, if necessary, that the Commission determine whether the clearing organization is eligible to clear swaps; and (2) to submit a swap to the Commission for review.
In addition, the regulation sets forth a reasonable process for a swap counterparty to request that the Commission stay a clearing requirement pending review. However, it is not enough for the Commission to simply establish a process for clearing organizations and swap counterparties to request or contest clearing determinations. In their comments to the Commission, market participants, as well as international regulators, have requested more transparency and clarity on substance. For example, they have requested greater certainty on the criteria that the Commission will use to determine whether mandatory clearing is appropriate for a swap.
I recognize that such specificity will not be provided in this rule. Instead, I have drafted a letter that I will be sending to clearing organizations and market participants seeking their input on further defining the various thresholds and standards that the Commission should consider in determining whether a swap should be subject to mandatory clearing. (See Attachment). I hope to receive comments during the 60 days prior to the effective date of this rule, and I hope that such comments will inform staff discussions going forward. Given our emphasis on clearing to manage systemic risk, to move forward on mandatory clearing without written guidance is irresponsible. It is also arguably an abrogation of our responsibilities under Section 2(h)(3)(D) of the CEA, as amended by the Dodd-Frank Act.5 I also hope that such comments will inform a roundtable discussion, as well as written guidance, on these important questions.
Another concern that I have with this rule is that it overreaches in interpreting Section 723(a)(3) of the Dodd-Frank Act, and in Regulation 39.5(c)(3)(iii). Basically, the final regulation leaves open the possibility that the Commission could impose capital and margin requirements directly on end-users exempt from the clearing requirement. This interpretation contradicts the letter from Senator Christopher Dodd and Senator Blanche Lincoln, which states, among other things, that “Congress clearly stated in this bill that the margin and capital requirements are not to be imposed on end users.” Further, the final regulation permits the Commission to impose capital and margin requirements on bank swap dealers and bank major swap participants. Understandably, the Office of the Comptroller of the Currency, our fellow regulator, disagrees.
Customer Clearing Documentation, Timing of Acceptance for Clearing, and Clearing Member Risk Management
I oppose the two proposed rulemakings on (i) Client Clearing Documentation and Timing of Acceptance for Clearing and (ii) Clearing Member Risk Management. Both proposals fail to conform to the type of responsible rulemaking that I have tried to persuade the Commission to endorse. The two proposed rules before us today put the cart ahead of the horse. Neither rule is mandated under Dodd-Frank, nor are they well grounded in statutory authority. Further it is unclear as to what resources the Commission will utilize to administer these two new optional rules.
Without statutory direction and given the massive number of rules already under consideration, I imagined the Commission would have developed a justification for the policy recommendations before us today. Unfortunately, neither the Commission nor the staff held a single hearing to understand whether or not we have a serious problem, or we are drafting rules in search of a problem.
Setting aside the flawed process in the development of these rules, this first proposal regarding client clearing documentation may be attempting to solve a problem that no longer exists. The proposal alleges that a voluntary annex to a voluntary model agreement from two industry associations6 may restrict open access to clearing and harm competitive trading. I understand that more than 60 market participants, on both the buy- and sell-sides, discussed the voluntary model agreement over a period of several months. The final agreement reflected an accommodation – even if imperfect – of their respective interests.7
I am very supportive of maximizing the effectiveness of clearing. I do not want any artificial barriers to clearing, such as needless credit or position sub-limits. Based on the practices in the futures market, I am also quite certain that technology is available to ensure timely acceptance of trades. However, as the second part of this rulemaking (i.e., the Timing of Acceptance for Clearing) makes evident, the industry must still resolve a number of operational issues. Therefore, there may be a role for certain types of documentation. Ideally, the buy-side, sell-side, and clearing organizations will continue their dialogue on such documentation. Before substituting Commission judgment for private consensus, I hope the Commission will host a public roundtable and a Commission meeting to see if the restrictions and anticompetitive effects alleged in this rulemaking exist, and, if so, how to resolve these issues to everyone’s satisfaction.
The second proposal regarding clearing member risk management fails to justify its costs in light of its benefits. First, as I mentioned previously, the proposal is neither mandated by the Dodd-Frank Act nor any provision in the CEA. Second, the proposal would require the Commission to ascertain whether clearing members are following certain risk management procedures. However, under another rulemaking, the Commission assigns the same responsibility to clearing organizations.8 Given our resource constraints, the Commission should focus on supervising clearing organizations – the main bulwarks against systemic risk. The Commission should ensure that clearing organizations are fulfilling their self-regulatory responsibilities, and adequately evaluating the risk management of its members. The Commission should not divert its resources to directly auditing clearing members, the failure of any one of which may be non-systemic.
Frankly, I would rather see the Commission dedicate resources towards developing real-time trade surveillance capabilities, rather than developing a redundant oversight function that will require additional resources we don’t possess. As our President has advised, we will be held accountable.
Mr. Chairman, I greatly appreciate the hard work of the staff and I sincerely hope you will provide an answer as to whether or not the Commission will publish a rule making schedule and an implementation timetable that includes dates to give the market and its participants an unambiguous strategy for implementing the Dodd-Frank rules. I also hope you will commit to publishing our draft rules when you publish the notice regarding all commission meetings.
I am writing to seek your input on a number of important questions regarding the review of swaps for mandatory clearing under Section 723 of the Act. Specifically, the Commission promulgated a final rulemaking on July 19, 2011 regarding the process that the Commission will follow for: (i) determining the eligibility of a derivatives clearing organization (“DCO”) to clear swaps; (ii) the submission of swaps by a DCO to the Commission for a mandatory clearing determination; (iii) Commission-initiated reviews of swaps; and (iv) staying of a clearing requirement.9 Since the final rulemaking focuses on process, it does not provide guidance on, among other things, the manner in which the Commission will determine (i) which swaps would be subject to the clearing requirement and (ii) whether to issue a stay of a clearing requirement. 10
The final rulemaking will become effective within sixty (60) days of being published in the Federal Register. On [__________], the Commission plans to publish, for public comment, DCO submissions relating to swaps listed for clearing as of the date of enactment of the Act (the “Pre-Enactment Swaps”). Before the Commission begins reviewing Pre-Enactment Swaps, I believe that it would be helpful for guidance to be developed regarding the substantive aspects of such review. To that end, I seek your opinion on the following questions:
1. Section 2(h)(2)(D) of the Commodity Exchange Act (“CEA”) states:
In reviewing a swap, group of swaps, or class of swaps..., the Commission shall take into account the following factors:
(I) The existence of significant outstanding notional exposures, trading liquidity, and adequate pricing data.
(II) The availability of rule framework, capacity, operational expertise and resources, and credit support infrastructure to clear the contract on terms that are consistent with the material terms and trading conventions on which the contract is then traded.
(III) The effect on the mitigation of systemic risk, taking into account the size of the market for such contract and the resources of the derivatives clearing organization available to clear the contract.
(IV) The effect on competition, including appropriate fees and charges applied to clearing.
(V) The existence of reasonable legal certainty in the event of the insolvency of the relevant derivatives clearing organization or 1 or more of its clearing members with regard to the treatment of customer and swap counterparty positions, funds, and property.
1. How should the Commission consider the five factors?
a. What criteria should the Commission consider when evaluating whether the DCO has properly categorized “group, category, type, or class of swaps”?
b. Should the Commission accord more weight to one or more of the factors than others? If so, why?
c. Should the Commission consider the factors differently depending on asset class (e.g., interest rate swaps, credit default swaps, and physical commodities)? If so, how should the Commission consider the factors for each asset class (or instruments therein)?
d. To what extent should the Commission take into account, in its consideration of the five factors, the connection between (i) mandatory clearing under Section 2(h)(1) through (4) of the CEA and (ii) the trade execution requirement under Section 2(h)(8) of the CEA?
e. Final regulation 39.5(b)(3) sets forth a list of documents that each DCO must submit in its request for a mandatory clearing determination. What, if any, additional information should the Commission routinely obtain to aid in its consideration of the five factors? Please indicate the specific factor (and element therein) that such information would help the Commission evaluate.
2. Section 2(h)(3) of the CEA states: “After making a determination…, the Commission, on application of a counterparty to a swap or on its own initiative, may stay the clearing requirement…until the Commission completes a review of the terms of the swap (or the group, category, type, or class of swaps) and the clearing arrangement.”
a. What criteria should the Commission employ to determine whether staying the clearing requirement would be appropriate?
Thank you in advance for your time and attention to this issue. Please submit your comments electronically to the General Dodd-Frank Submissions folder at: http://comments.cftc.gov/PublicComments/ReleasesWithComments.aspx. Please also email your comments to [__________]. I would encourage you to submit your comments by [__________], given that the Commission plans to publish DCO submissions relating to the Pre-Enactment Swaps on [__________].
Please do not hesitate to contact me if you have any questions.
1 Memorandum on Transparency and Open Government, 74 Fed. Reg. 4685 (Jan. 21, 2009).
2 Barack Obama, Toward a 21st-Century Regulatory System, The Wall Street Journal, Jan. 18, 2011.
3 Exec. Order No. 13,563, 76 Fed. Reg. 3821 (Jan. 21, 2011).
4 Exec. Order No. 13,579, 76 Fed. Reg. 41,587 (July 14, 2011).
5 Section 2(h)(3)(D) of the CEA, as amended by the Dodd-Frank Act, states: “Not later than 1 year after the date of the enactment of the Wall Street Transparency and Accountability Act of 2010, the Commission shall adopt rules for reviewing, pursuant to this paragraph, a derivatives clearing organization’s clearing of a swap, or a group, category, type, or class of swaps, that is has accepted for clearing.”
6 The two industry associations are: (1) the Futures Industry Association (“FIA”) and (2) the International Swaps and Derivatives Association (“ISDA”). The proposal references the FIA-ISDA Cleared Derivatives Execution Agreement, and certain annexes to the agreement.
7 For example, the joint FIA-ISDA press release quoted Richard Prager, managing director and head of global trading at BlackRock, as stating: “The derivatives industry’s collaborative effort has resulted in a modular give-up document that meets the needs of all market participants, promotes deep, liquid and efficient market structure and supports principles of the Dodd-Frank Act.”
8 See Risk Management Requirements for Derivatives Clearing Organizations, 76 Fed. Reg. 3698 (Jan. 20, 2011).
9 See Process for Review of Swaps for Mandatory Clearing, [___] Fed. Reg. [___], ([___________]).
10 See Section 2(h)(3)(D) of the CEA (stating that “…the Commission shall adopt rules for reviewing, pursuant to this paragraph, a derivatives clearing organization’s clearing of a swap, or a group, category, type, or class of swaps, that it has accepted for clearing.”).
Last Updated: July 19, 2011