December 1, 2010
Mr. Chairman, I would like to thank the teams who have worked so hard on the rules we will consider here today. The staff continues to seek input from the Commissioners and worked diligently over Thanksgiving to improve each of these rulemakings.
I would like to commend the various teams who will be presenting today which are headed by Phyllis Dietz, Nancy Markowitz, Sarah Josephson, and Mark Fajfar. I appreciate your unwavering commitment to responding to my staff’s questions, comments, and criticism with thoughtful consideration.
This is our sixth in the series of proposed rulemakings under the Dodd-Frank Act and while the format is becoming routine, the content is anything but. I am concerned that these rules present a deluge of potential outcomes that we haven’t fully explored and that may have negative impact on the markets we regulate.
Swap Dealers and Major Swap Participants
While reasonable people will continue to debate who should ultimately fall into the regulatory category of “swap dealer” for years after final rules are promulgated, one thing we should all be able to agree on here today is that the rule should be clear as to who falls into this category and who does not. Unfortunately, the 145 page proposed rule does not provide the regulatory certainty that I believe many market participants are seeking, particularly commercial end users. In fact, I have concerns that many end users will be unintentionally swept up in the dealer definition and be subject to significantly higher costs to hedge their commercial risk.
I commend staff for their attempts to characterize the activities of a dealer based on the limited statutory direction. I would have preferred to see a more thorough discussion of a range of safe harbor activities that end users will clearly understand; they need to know whether or not their bilateral swaps activities will cross the line and earn them the dreaded scarlet letters “SD” for swap dealer.
I strongly encourage the market to comment on the proposal establishing what I perceive as a very limited de minimis standard for swap dealing conduct that will result in few exemptions. I hope that the public comments will focus on this proposal and will provide guidance as to the appropriate size of a de minimis exclusion and whether it should be adjusted by asset class.
It is my hope that after reviewing the public comments, the final swap dealer rule can be significantly improved by providing greater specificity to the dealer definition, and considerably narrowing the definition to focus only on those entities that perform traditional dealer roles.
I know the end users are anxiously awaiting the publication of this rulemaking. Mr. Chairman, with regard to the Capital and Margin rulemaking I would like to thank you for your willingness to delay this rulemaking, which I recognize will take the Commission off schedule in order to conduct an important hearing on this complex matter. I believe, at the end of the day, the draft proposal will be better informed after receiving public input prior to publication of the draft proposal.
Reporting, Recordkeeping and Daily Trading Records Requirements for Swap Dealers and Major Swap Participants
I was particularly pleased with the careful consideration that Sarah Josephson’s team gave to the technological advancements of recent years that have lowered the costs and increased the feasibility of capturing and retaining communications regardless of their original format, as well as the international efforts to expand recordkeeping requirements to embrace such progress.
Given that we have yet to define the facilities upon which many of the effected transactions will take place, it makes it especially difficult to define the records (and associated costs of recordkeeping) necessary to conduct comprehensive and accurate trade reconstructions as required by the Act. I look forward to receiving comments on this particular rulemaking.
Core Principles and Other Requirements for Designated Contract Markets (DCMs)
The notice of proposed rulemaking that codifies and interprets the core principles that applicant contract markets must comply with to become designated, and that they must continue to comply with on an ongoing basis, was obviously quite an undertaking. I appreciate the team’s hard work.
I would especially like to thank the team for considering under Core Principle 4 different risk controls that a DCM should employ to effectively prevent market disruption. On November 19th, I established a subcommittee of the Technology Advisory Committee, chaired by Dr. Michael Gorham a former Director of the CFTC’s Division of Market Oversight. I have asked Dr. Gorham and the other subcommittee members to conduct a review and provide recommendations of applying pre-trade functionality at the direct access participant/trading firm, clearing house, and exchange levels. As a baseline, the subcommittee was advised to consider the FIA’s work with regard to market access risk management recommendations and risk controls for trading firms. It is my expectation that the recommendations or regulatory guidance, as the case may be, will provide a roadmap for the application and implementation of best practices with regard to Direct Market Access and pre-trade functionality while appropriately steering the Commission in the right direction with regard to identifying and mitigating disruptive trading practices.
I have serious concerns about many of the other provisions of this proposal. The Commission’s core principle regime has worked well, providing flexibility to adapt to innovations in our markets. This notice moves significantly away from our principles based regime by adopting several regulatory requirements interpreting core principles in prescriptive ways, instead of maintaining guidance or safe harbors in acceptable practices.
For example, Dodd-Frank amended Core Principle 9 to include language that boards of trade must provide mechanisms for executing transactions in a way that protects the price discovery process of trading in the centralized market. At the same time, the core principle explicitly states that boards of trade may authorize exchange of futures for swaps trades (EFS). The statutory language of Dodd-Frank specifically permits the trading of swaps on DCMs as well as on SEFs. Staff’s interpretation of Core Principle 9’s language that the price discovery process must be protected, however, requires that 85% of the trading in a contract must be through the centralized market for the contract to continue to be listed on a DCM. The practical effect of that interpretation may very well be that few, if any, swaps will still be executed on a DCM, and the contracts known as EFSs will no longer be able to operate as futures and will be forced to trade on SEFs.
There are likely many negative implications of this interpretation, and because it is on its face contrary to the statutory language in Dodd-Frank, I have great concerns about this proposal.
Further, this proposal will likely create uncertainty for traders regarding the protections that their segregation account funds will receive if they are required to execute contracts on SEFs instead of DCMs, and whether or not they will be able to continue to avail themselves of certain Commission approved market efficiencies, like portfolio margining pursuant to a Section 4(d) order, that they are able to use when they are trading both swaps and futures on a DCM.
There are other examples of where this proposal creates regulatory requirements that exceed the articulated core-principals in Dodd- Frank. More specifically, Core Principle 9 has also been interpreted by staff to support a regulatory requirement regarding block trades. I hope the public will not overlook this proposal and will provide comment on this.
In closing let me thank my staff and the rulemaking teams for their hard work over the thanksgiving holiday. I know everyone is making sacrifices by putting rulemakings ahead of their family over the holiday. I want everyone to know how much I appreciate their efforts.
Last Updated: January 18, 2011