August 4, 2011
Consideration of Final Rules: Swap Data Repositories: Registration Standards, Duties and Core Principles; Implementing the Whistleblower Provisions of Section 23 of the Commodity Exchange Act; Agricultural Swaps
Today, we are voting on the third tranche of final rules to implement the Dodd-Frank Act. Before we begin, I would like to join my colleagues in thanking the three teams for their dedication and hard work on these final rules. I intend to support the Swap Data Repository, Agricultural Swaps, and Whistleblower rules, because they reach the right results. I oppose scheduling any further meetings until a comprehensive rulemaking implementation schedule is available for public comment.
Swap Data Repositories: Registration Standards, Duties and Core Principles
Pursuant to the Commodity Exchange Act (CEA), the Commission has the responsibility to ensure, among other things, orderly markets and the financial integrity of transactions within such markets. Further, the Commission has the responsibility to avoid systemic risk. In order to fulfill its responsibilities, the Commission must receive accurate information on the markets within its jurisdiction. Once established, swap data repositories (SDRs) will not only provide the Commission (and other domestic and foreign regulators) with comprehensive data on the swaps market, but they will provide the public, for the first time, a reliable means for price discovery.
As many of my colleagues and several commenters have aptly noted, the information and records gathered, screened, stored and analyzed by SDRs should inform the Commission’s rule- and policy-making going forward. Because we are currently under rulemaking deadlines that will come to pass months before the first SDRs are even required to be up and running, we must be flexible and cognizant that some of our final rules may ultimately need to be revisited. This should not surprise anyone; Congress knew we did not have data on the swaps market. To quote my esteemed colleague, Commissioner Bart Chilton, we needed this swap data “like yesterday.” 1
Recognizing the importance of SDRs to the regulatory infrastructure of the Dodd-Frank Act, this final rulemaking establishes a robust – yet flexible – approach towards SDR registration. To a greater extent than other Commission actions, this final rulemaking roots SDR regulation in principles, instead of prescriptive requirements. Acknowledging that the Commission has limited experience in regulating entities similar to SDRs, this final rulemaking explicitly states that the Commission may study the effects of its regulations, and may reevaluate such regulations if warranted.2 For these reasons, this final rulemaking – along with its drafters – are to be commended.
However, inasmuch as the rulemaking formulates the registration and regulation of SDRs, it does not attempt to resolve some of the most critical issues linked to the role of SDRs in the swaps markets. For example, this rule does not address the fundamental question as to who owns swap data. Between the swap counterparties, the swap execution facility, the derivatives clearing organization or the SDR, it remains unclear as to who owns and has rights to make commercial use of the actual data. I recognize that given the commercial use limitations proscribed in Part 49 of the Commission’s rules, we are seeking to temporarily avoid this issue by speaking in terms of possession, as opposed to ownership, of the data. However, given that old adage that possession is nine-tenths of the law, I am not so confident we are dodging any bullets by refraining to speak on this issue.
Additionally, the final rules before us today do not address the role that SDRs will play in the public dissemination of real-time swap data and in determining the appropriate minimum block trade sizes. While I understand that the Commission will address these issues in the finalization of separate rules under Part 43, I cannot help but ask whether the disconnect between the rulemakings will negatively impact the final rules for both Parts 49 and 43.3 Both Commission rulemaking teams have worked at a feverish pace to complete these final rules, and this has certainly caused the development of the rules to occur in silos, even where it is clear that the rules interact. I do not fault the teams, however, because without an implementation or phasing schedule, there is nothing to compel coordination. The teams have marching orders, and I have been more than clear as to how I feel about that.
Turning to another topic of particular interest to me, SDRs will be the foundation of our oversight efforts and the foundation of our technology program. The Commission must take the next step, and formulate a technology strategy for: (i) ensuring adequate CFTC connectivity to each SDR; (ii) internally aggregating SDR information with futures information; and (iii) automating surveillance of such information (for both market and credit events).
It is my expectation that the finalization of the SDR registration rule today is the end that will get the Commission to focus on the means by refocusing its priorities on expanding our technological capabilities. In June, I respectfully dissented from the FY 2011 spending plan because it continues to concentrate resources on an ever-expanding staff hiring plan that is both fiscally unsustainable and detrimental to the Commission’s already ailing technology programs.4 Moreover, the Commission ignored the explicit Congressional directive establishing a $37.2 million floor for technology spending and instead made $37.2 million the cap. Even more astounding, the Commission completely ignored statutory direction and failed to allocate funding towards highest-priority projects, such as automated surveillance. Regardless of who or what may ultimately become an SDR, the Commission will ultimately retain the responsibility for surveillance and oversight of the swaps market.
Implementing the Whistleblower Provisions of Section 23 of the CEA
Today’s rules implementing the whistleblower provisions of the CEA represent a good compromise and balance of some very challenging competing interests. The Commission has never before had policies or procedures for the treatment of whistleblowers, let alone has it had the authority to provide awards for their assistance. The Commission faces a steep learning curve, and I expect the Commission to recruit the most qualified individuals to develop this new program and office.
I am pleased that the final rules commit the Commission to funding and establishing an Office of Consumer Outreach tasked with the design and execution of initiatives to help consumers protect themselves against fraud and other violations of the CEA. In April, I held a public meeting to begin the dialogue among individuals, organizations and fellow regulators at the forefront of the most successful financial literacy, education and outreach programs to advise the Commission as to how to establish a quality consumer education and outreach program. I was overwhelmed by how little the CFTC had done in this area as compared to our fellow federal financial regulators, especially in the post-financial crisis world where commodities have become a favored investment class with consumers seeking exposure in metals, oil and gas, and currencies. In many cases, consumers are not well informed about the fees, investment strategies or the structure of the investment itself.
Consumers are facing more sophisticated, more complex and more diverse financial markets than ever before. While the amount of available information is astounding as compared to any other time, it is also deeply complex. New products are coming out every day, and technological developments are creating more distribution and communication channels than ever before. We’ve got increasing numbers of new participants in our regulated markets, and should help ensure the integrity of our markets by helping participants understand the risks and how to manage them.
The final rule before us today regarding Agricultural Swaps is the second in a series of rulemakings related to this topic. Like the one before it, this rulemaking is well done and succinctly provides the public with the certainty it will need to continue to trade agricultural swaps. Unfortunately, because we are yet to publish either a schedule for the consideration of the final rules, or more importantly, a draft implementation schedule, this rule is another example of how unnecessarily confusing the effective date provisions of different inter-related rules can become. We have allowed other rulemakings, like the final rules on Large Trader Reporting for Physical Commodity Swaps,5 to continue to depend on the same Part 35 provisions that this final rule on Agricultural Swaps will remove and replace. We could spare the public a great deal of confusion if we were to consider rules in a more orderly fashion and provide the public with an implementation schedule that makes sense.
As I mentioned above, I intend to support the three final rulemakings, because they reach the right ends. However, in rulemaking – as in much else in life – the ends do not always justify the means. As the Commission moves forward, I hope that the Commission begins to think more critically about the final rulemaking process, and whether that process best serves the American people. I hope that the Commission, after honest evaluation, will begin to embrace the transparency and accountability that President Obama himself espouses, rather than the opacity and expediency that have characterized certain rulemakings.
As I have stated time and again, the final rulemaking process currently affords insufficient transparency to market participants and the public. First, despite my repeated requests, we again have failed to set forth an implementation schedule. In our last public hearing, I specifically asked the Commission to publish an implementation schedule at this hearing, so that market participants and the public would have August to comment. Now, even if the Commission sets forth an implementation schedule in early fall, public comment will likely be irrelevant to certain major rulemakings. Specifically, teams for September and October rulemakings may have the discretion to reject public comments on effective or compliance date provisions. I urge the Commission to not permit this situation to come to pass. Therefore, I will not support scheduling further meetings until a comprehensive schedule is produced that allows for public comment.
Second, despite my repeated requests, we have not published the final rulemakings for today seven (7) days in advance. Again, members of the public may be sitting in the audience or in front of their computers, watching us speak, without having an opportunity: (i) to review the final rules beforehand, and (ii) to see if our questions address their concerns. I would imagine, from their perspective, that watching Commission hearings would be similar to watching the Ring Cycle without English subtitles. This Commission can do better, and it should do better.
Weighing of Costs and Benefits
Our economic recovery is weakening. The data is incontrovertible. As the Wall Street Journal reported on Tuesday, American incomes rose only 0.1% in June, in contrast to 0.2% in May. Similarly, American spending decreased 0.2% in June, in contrast to increasing 0.1% in May. As the Wall Street Journal stated: “The report was in line with other evidence of a poorly performing economy, including data last week on gross domestic product. The GDP numbers showed the economy grew little in the first half of 2011. Beset with higher gasoline prices and joblessness, Americans pulled back their spending in the spring.”6
In this economic environment, the Commission should be more conscious than ever in ensuring that the benefits of its rulemakings justify their costs. Cost-benefit analysis should be central to every Commission proposal, whether initial or final. Even if President Obama had not issued two Executive Orders emphasizing the importance of quantitative cost-benefit analyses,7 the Commission should conduct such analyses. Furthermore, the Commission should detail its rationale for choosing to propose and adopt specific prescriptive requirements, especially since principles-based alternatives may be equally effective and less costly.8 Now that we are engaging in final rulemaking, the Commission can no longer ignore the full implication of its rulemakings on Main Street. As I previously emphasized, the outcome of Commission rulemakings may directly impact the food and energy costs of average Americans.9
I am disappointed to say that, during the course of final rulemakings, I have seen indications that the Commission intends to continue with a “one size fits all” approach to cost-benefit analyses,10 instead of embracing its responsibilities under the Executive Orders. For example, I reviewed a version of the rulemaking on the Investment of Customer Funds, which was purported to be final and ready for Commission vote. One major Commission registrant has publicly stated that the costs of that rulemaking may lead it to reconsider its role in derivatives intermediation for customers.11 Nevertheless, the cost-benefit analysis of the rulemaking did not contain one single dollar sign. This clearly indicates that the Commission hasn’t come close to fulfilling our statutory obligation.
Fortunately, the Commission has chosen not to vote on Investment of Customer Funds today. That rulemaking is just one example, however, of how we can do better. The Commission should proactively review the cost-benefit analyses of every rulemaking against the Executive Orders, focusing on quantification and more comprehensive examination of less costly alternatives. If the Commission needs to re-propose a rulemaking, then so be it. It is more important to get a rulemaking right than to finish it fast.
I would remind the Commission that with respect to cost-benefit analyses, as well as other rulemaking processes, the Commission does not have the last word. As the Inspector General noted in both of his reports, whereas “[t]he Commission’s performance under section 15(a) of the Commodity Exchange Act has never been challenged,” “in recent years the courts have identified weaknesses in the application of economic analysis to regulatory decisions, resulting in rules being sent back to regulators for further consideration.”12 If CFTC rulemakings are subject to litigation, the markets may face years of uncertainty. The time to avoid that outcome – which is satisfactory to no one – is now.
Thank you, Mr. Chairman. I will now close by again thanking the teams before us for their hard work, patience and cooperation.
1 Bart Chilton, Commissioner, Commodity Futures Trading Comm’n, Like Yesterday: Statement of Commissioner Bart Chilton in Support of President Obama’s Remarks on Reining in Banks (Jan. 22, 2010), available at www.cftc.gov/PressRoom/SpeechesTestimony/chiltonstatement012210.html.
2 See Swap Data Repositories: Registration Standards, Duties and Core Principles, [___] Fed. Reg. [___] ([_____]) to be codified at 17 C.F.R. pt. 49).
3 See Real-Time Public Reporting of Swap Transaction Data, 75 Fed. Reg. 76,140 (proposed Dec. 7, 2010) (to be codified at 17 C.F.R. pt. 43).
4 Scott D. O’Malia, Commissioner, Commodity Futures Trading Comm’n, Dissent of Commissioner Scott D. O’Malia to the Fiscal Year 2011 Commission Spending Plan (June 16, 2011), available at www.cftc.gov/PressRoom/SpeechesTestimony/omaliastatement061511b.html.
5 Large Trader Reporting for Physical Commodity Swaps, 76 Fed. Reg. 43,851 (July 22, 2011) (to be codified at 17 C.F.R. pts. 15 and 20).
6 Jeff Bater and Tom Barkley, “Data Reinforce Economic Malaise,” The Wall Street Journal, Aug. 2, 2011, available at http://online.wsj.com/article/SB10001424053111903520204576483882838360382.html?mod=WSJ_hp_LEFTWhatsNewsCollection. See also, the Associated Press, “Spending Fell and Income Barely Rose in June,” The New York Times, Aug. 2, 2011, available at http://www.nytimes.com/2011/08/03/business/economy/spending-down-incomes-barely-up.html?ref=business (stating that “Many Americans are cutting back on purchases of cars, furniture, appliances and electronics. Employers have responded by reducing hiring. The economy added just 18,000 net jobs in June, the fewest in nine months. The unemployment rate rose to 9.2 percent, the highest level this year.”).
7 See Exec. Order No. 13,563, 76 Fed. Reg. 3821 (Jan. 21, 2011). That order, entitled Improving Regulation and Regulatory Review, states that “[o]ur regulatory system…must take into account benefits and costs, both quantitative and qualitative.” It also states, “In applying these principles, each agency is directed to use the best available techniques to quantify anticipated present and future benefits and costs as accurately as possible.”
See also Exec. Order No. 13,579, 76 Fed. Reg. 41,587 (July 14, 2011). That order, entitled Regulation and Independent Regulatory Agencies, states that “[t]o the extent permitted by law… [regulatory] decisions should be made only after consideration of their costs and benefits (both quantitative and qualitative).”
8 See Exec. Order No. 13,563, 76 Fed. Reg. 3821 (Jan. 21, 2011) (stating that “[t]o the extent permitted by law, each agency must …to the extent feasible, specify performance objectives, rather than specifying the behavior or manner of compliance that regulated entities must adopt.”). Exec. Order No. 13,579 states that independent regulatory agencies, as well as executive agencies, must comport with the abovementioned standard.
9 See, e.g., Statement of Randy S. Howard, Director of Power System Planning & Development, Power System Exec. Office, Dept. of Water & Power, City of Los Angeles, Derivatives Reform – The View from Main Street: Hearing Before the House Comm. on Agric., 112th Cong., (July 21, 2011) (stating that “Several important definitions are still being drafted by CFTC and will impact LADWP and other utilities. In particular, we are concerned that individual LPPC members could be considered a ‘swap dealer’ due to certain transactions we use to hedge our costs. LADWP and the members of LPPC do not belong within this definition, as we hedge strictly to minimize commercial risk and do not contribute to systemic risk of the market. If our utility systems were regulated as swap dealers, our ratepayers – the residents and businesses which we are obligated to serve – would be swept into the same regulatory regime meant to target financial speculation.”).
10 See Office of the Inspector General, Commodity Futures Trading Commission, An Investigation Regarding Cost-Benefit Analyses Performed by the Commodity Futures Trading Commission in Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank Act: Report of Investigation, April 15, 2011, p. 21, (“[i]t appears that the Commission generally adopted a ‘one size fits all’ approach to section 15(a) compliance without giving significant regard to the deliberations addressing idiosyncratic cost and benefit issues that were shaping each rule, and were often addressed in the preamble.”), available at: http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/oig_investigation_041511.pdf.
11 See Matthew Leising, “MF Global May Exit Clearing if CFTC Rule Limits Investments,” Bloomberg, June 9, 2011.
12 Office of Inspector General, supra note 10, at 23; see also Office of the Inspector General, Commodity Futures Trading Commission, A Review of Cost-Benefit Analyses Performed by the Commodity Futures Trading Commission in Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank Act, June 13, 2011, p. 28, available at: http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/file/oig_investigation_061311.pdf.
Last Updated: August 4, 2011