September 8, 2011
Mr. Chairman, I would like to begin by thanking you for scheduling this hearing to discuss the important issue of implementation of our Dodd-Frank rulemakings. I would also like to thank the team responsible for preparing the two proposals before us. I understand that these proposals aim to provide greater certainty to the market as to when the Commission will impose the clearing and trading mandates, as well as when the Commission will require compliance with certain documentation and margining rules. I am grateful that the Commission has attempted to provide more certainty. However, I fear that the market will find that these proposals raise more questions than they answer. These proposals fail to facilitate a transition to the new regulatory regime in the orderly manner that the market – as well as the Commission – desires.
Implementation: What We Don’t Know
Rather than defining what we know, these proposals emphasize what we don’t know about the implementation plan. I would just like to highlight six areas where more guidance is necessary so that market participants could have begun to allocate resources appropriately.
First, the proposal for the clearing and trading mandates may not apply in certain situations. The proposal states, “When issuing a mandatory clearing determination, the Commission would set an effective date by which all market participants would have to comply. In other words, the proposed compliance schedules would be used only when the Commission believes phasing is necessary based on the considerations outlined in this release.” Therefore, despite the proposal, market participants would need to look at each individual mandatory clearing determination to ascertain whether the specified phasing would apply. To date, neither the Commission nor staff has issued any guidance on the substantive criteria that will be used to make mandatory clearing determinations, including any criteria relating to when such determinations would become effective.
Second, neither proposal provides market participants with beginning nor end dates. For example, the proposal for the clearing and trading mandates appropriately states that the Commission must finalize no less than five rulemakings before it can trigger the specified compliance phasing schedule. Those rulemakings include: (i) entity definitions; (ii) the end-user exception; (iii) the protection of cleared swaps customer contracts and collateral; (iv) core principles for designated contract markets; and (v) core principles for swap execution facilities. The proposal provides no insight as to when the Commission anticipates finalizing these rulemakings.
Third, these proposals only address a handful of the requirements that market participants will need to comply with when the Commission finalizes all of the Dodd-Frank rulemakings. For example, the proposal relating to documentation and margining acknowledges that, in addition to the rulemakings that the compliance schedule addresses, swap dealers and major swap participants would need to comply with “rules proposed under Section 4s(e) (capital requirements), Section 4s(f) (reporting and recordkeeping), Section 4s(g) (daily trading records), Section 4s(h) (business conduct standards), Section 4s(j) (duties, including trading, risk management, disclosure of information, conflicts of interest, and antitrust considerations), and Section 4s(k) (designation of a chief compliance officer).” Although long, this list includes only the entity-specific rulemakings. It does not include more market-wide obligations such as mandatory clearing and trading. The Commission should have proposed a comprehensive schedule detailing: (i) for each registered entity, compliance dates for each of its entity-specific obligations under Dodd-Frank; and (ii) for each market-wide obligation, the entities affected (whether registered or unregistered), along with appropriate compliance dates. Instead, we again choose to leave the market to review the effective date sections of each final rulemaking in a vacuum. If the Commission is making this choice because the Commission itself is still not clear on how all of its proposals will work in concert together, and how the industry might be able to comply with such proposals, then we have not taken the important step of truly understanding the costs and benefits of our mosaic of rules.
Fourth, these proposals do not make it clear why the Commission has decided to phase implementation on 90, 180, and 270-day timeframes. Several participants in the May 4, 2011, implementation roundtable sought longer timeframes to accommodate, among other things, documentation requirements. For example, the Managed Futures Association proposed a 120, 210, 270 day tiered implementation approach. The proposals fail to accommodate these comments, and does not justify why or estimate the cost of the Commission’s approach.
Fifth, the proposals incorporate an incomplete and inadequate cost-benefit analysis. The proposals boldly and oddly characterize themselves as relief from time frames in other proposals or in determinations that the Commission has not yet made. I reiterate: the Commission should have proposed a comprehensive schedule that would have complemented and informed existing proposals and provided structure to future determinations. The Commission should then have analyzed the costs and benefits of the comprehensive schedule, including appropriate quantification.
With respect to market-wide obligations, such as the clearing and trading mandate, we know that the technology investments required for implementation will be massive. New clearing and trading entities, as well as data repositories, all need to be connected to each other and to firms. In developing back office systems alone the TABBGroup estimated that the industry would spend in 2011 over $3.4 billion globally and $1 billion in the United States. With respect to entity-specific obligations, firms will have to make large investments in new software to manage new margin requirements, price aggregation systems and risk management systems. Knowing when and how the markets are required to deploy these systems is vital to the success of implementing the new market structure required under the Dodd-Frank Act. When billions of dollars are at stake you simply do not rely on guesses and estimates based on vague conditions. Unfortunately, the proposals do not mention technology requirements and the costs required to execute the strategies.
Finally, on a substantive note, this rule discusses issues such as what is meant by “made available to trade.” It is clear that the Commission has yet to communicate what this standard means. Instead of signaling that we need to address this issue, the Commission is silent. Similarly, instead of making it clear that the Commission will publish guidance on how mandatory clearing determinations will be made, it is still unclear how that process will work. The rule proposals also fail to ask some important questions, like how the Commission’s proposed implementation requirements will affect entities and transactions located outside of the United States.
Implementation: The Reality
These proposals do accomplish one thing. They force us to wake to reality and recognize that the earliest the Commission can complete the last of the triggering rules is the end of the first quarter of 2012. As I previously mentioned, those rules must be finalized before the Commission can begin phasing in compliance. The realities of this schedule will push the clearing and trading mandate to approximately the third quarter of 2012, or just before the G-20 commitment to implement clearing. We cannot continue to pretend, as we did when the Commission published its Effective Date Order, that all of the Dodd-Frank rulemakings will be in place by December 31, 2011, and that the Commission will be able to thoughtfully consider final rulemakings at the untenable pace that would be necessary to meet that arbitrary deadline.
I want to be clear. I support completing final rulemakings in a reasonable time frame. I believe that the timely implementation of such rulemakings is important. I am mindful, though, that it is not the Commission, but industry, that will do the real work of making the regulatory jargon and Federal Register pages that constitute our final rulemakings a functioning reality. If we want to promote timely implementation, we need to tell the industry when it will be expected to do what, so that in turn, it can make the costly investments in technology and staff that will be necessary to implement what are very complex requirements.
International Coordination and Extraterritoriality
Now, I would like to turn to another item on the agenda that is not a Dodd-Frank rulemaking, but that illustrates certain themes that the Commission has not addressed in a cohesive manner, either in the final rulemakings that it has adopted, the proposals before us today, or other proposals that it is in the process of finalizing. That item is the report by the International Organization of Securities Commissions (IOSCO) on Principles for the Regulation and Supervision of Commodity Derivatives Markets. The themes that I would like to focus on are international coordination and extraterritoriality.
First, on international coordination, it is becoming increasingly clear that the schedule for financial reform is converging among the G-20 nations. It is less clear that the substantive policies underlying financial reform is experiencing the same convergence. That fact may have competitive implications that the Commission has yet to examine fully. The IOSCO Principles illustrates some of the tensions surrounding international coordination that we have seen, and will continue to see, with respect to Dodd-Frank rulemaking. For example, while each IOSCO member supports the organization’s general principles, each member may have widely different interpretations of exactly what regulations would accord with such principles. For example, the IOSCO Principle on Intervention Powers in the Market states that IOSCO members should have “position management powers,” including powers to set both: (i) traditional position accountability limits; and (ii) ex ante position limits. However, the Principle acknowledges that different IOSCO members may place different emphases on the two powers and that ex ante position limits may be most useful in the delivery month. As we know, the Commission has set forth its position limits proposal. Regulators in other jurisdictions may set forth dramatically different proposals and still comport with the IOSCO Principle. How the Commission plans to manage international regulatory arbitrage, and how the Commission intends to enforce that plan, remains to be seen. I predict that this theme will run through many of our upcoming rulemakings, including those pertaining to core principles for derivatives clearing organizations.
Second, on extraterritoriality, in order for the Commission to coordinate internationally other regulators should ideally have an understanding of the manner in which the Commission perceives the boundaries of its jurisdiction, even if those regulators do not agree. To date, the Commission has produced nothing to afford other regulators, not to mention market participants, such understanding. Uncertainty delays crucial international dialogue on financial reform. I would urge the Commission to make its thoughts on extraterritoriality known sooner rather than later. I would also strongly urge the Commission to take a more comprehensive approach towards extraterritoriality, and an approach that is coordinated with the Securities and Exchange Commission (SEC), than it has chosen to take with respect to the proposals on compliance before us today.
Finally, a word on technology. To comport with the IOSCO Principles, the Commission needs to invest more than the minimum in technology. Only by investing more can we achieve the goals of real-time surveillance. Having “position management powers” means very little if the Commission lacks the tools to exercise those powers. Therefore, I am going to close by urging the Commission, as I have done many times in the past, to focus on improving its technological capabilities.
Thank you, Mr. Chairman.
Last Updated: September 8, 2011