December 16, 2010
Mr. Chairman, I am grateful this is the final rulemaking for 2010. As you noted, we have noticed 30 proposed rulemakings, four advanced notices, two interim final rules, and one final rule. While I am thankful that we have just a few more rulemakings left to complete in the new year, I recognize we are only halfway through the process – and it’s probably the case that the easiest portion is past us.
The next step is to digest the mountain of comment letters that I hope market participants will provide. Of course, I am assuming they have had time to read and consider the thousands of pages of proposed rules. For this process to be meaningful, we must ensure that the public has adequate time to digest each rulemaking and we must be mindful that they are working through a cumulative burden of thousands of pages of text and hundreds of questions posed by staff.
Since it is the holiday season, and I have already shared Macey’s list, I figure its time I shared my own wish list with the Commission. I have always operated under the premise that you don’t get what you don’t ask for.
My first wish is that the Commission will take the opportunity this spring to organize the rulemaking process in a manner that will build derivatives regulation from a strong foundation instead of the regulatory jumble that market participants are attempting to sort with every new rulemaking pushed out by the Commission.
That means beginning with clear definitions, trading platform criteria and governance. The next layer will involve clearing. Thereafter, block trades, reporting, and swap data repositories will move the information. Next would be capital and margin and business conduct standards. Finally, position limits based on actual data and prohibited trade practices should come at the tail end.
My second wish is always at the top of the list: technology. While we are working to establish the regulatory OTC structure, we can’t lose sight of fact that we must reorganize the Commission around technology. We have a massive challenge to move all forms and filings to a fully electronic data collection system that removes the human element from all the new reporting requirements. We must invest in automated trade surveillance systems that can see across markets – similar to the way the fastest algo shops trade today. It is my goal to establish an Office of Market Data Collection and Analysis that has the acquisition and use of data-related technology as its primary mission. This office should be led by a capable, forward thinking chief data officer who will be responsible for developing and articulating a strategic vision for the mission-critical functions associated with data management administration and a budget that doesn’t include laptops, blackberry support and toner cartridges.
My third wish is to improve our interface with the public. Building on the new whistleblower authority, we should organize a public education interface that responds to the influx of questions from the public and assist them in understanding the avenues for timely recourse to resolve disputes they may have with Commission registrants when they arise.
My last wish is that this agency will contribute what we can to resolving the federal budget deficit. It appears that Congress will not leave this agency with a lump of coal this Christmas, but instead with a very generous budget despite these difficult budgetary times. While believe the CFTC is the best investment for taxpayers on an hourly basis (especially since we began the rulemaking process); we must do our part recommend savings where we find waste – a feature endemic in every federal agency.
With regard today’s rulemaking, I am pleased to report that despite delaying the SEF definition a week, we have used the time well to develop a compromise solution that will bring more transparency to the dark markets of the OTC space. I am mindful that the statute provides flexibility and does not envision that the Commission will direct that the swaps market become a clone of the futures market. By in large this market remains illiquid by futures standards and trades in significantly larger blocks. Rather than reorganize the market, I prefer to facilitate the trading on execution platforms with the goal of increased competition and better pricing and transparency.
This compromise solution does not mandate a limit order book, but will allow participants to use a variety of trading systems and platforms, including order books, request for quote systems, and voice-based systems. It mandates only one requirement: that all SEFs maintain an electronic screen that displays all firm and indicative quotes to market participants. I believe this proposal preserves the ability of the end-users and the buy side to transact large size in these currently opaque and illiquid markets.
While I am pleased we have established sensible definitions, I have concerns with certain elements of this rule, and I hope that public comments will provide further guidance. First, the open access provisions in the preamble and the rule seem in conflict. Second, will this proposal continue to serve all markets and assets in a manner that is transparent and improve liquidity rather than fracture it? Finally, I question the relevance of the mandate to require traders to be reminded of firm quotes, which they previously ignored in a RFQ system, before executing their order.
Last week, I was helping Macey learn about our founding fathers and we spent considerable amount of time discussing Thomas Jefferson.
I am supporting today’s release of the proposed rulemaking regarding position limits, but I believe we may fall into one of Thomas Jefferson’s one liners: “Delay is preferable to error.”
As the staff has wrestled with this rulemaking, I have been constantly reminded that exchanges already impose and enforce specific position limits in the spot month based either in hard limits or 25% of deliverable supply. These limits, of course, only apply to futures markets and only to those contracts deemed to be significant price discovery contracts.
Without specific swaps data, we have no ability to claim we are applying enforceable limits without understanding the full size of the market. And this is something the Commission ought not be held accountable for.
While the proposal meets the mandates of the Dodd Frank Act, this proposal still suffers from significant flaws in its complexity, and the likelihood of achieving an end state of controlling “excessive speculation remains in question.” I am incredibly pleased that we have eliminated the proposed crowding out provisions altogether and provided for generous netting provisions. We have also provided for a broad bona fide hedge exemption that extends to the counterparty of a swap where the other party is hedging a cash market commodity risk. These are all good things and demonstrate a commitment to listen to the concerns of market participants.
The proposed limits as set forth stand to have the greatest impact on large concentrated positions in each class—meaning futures and options or swaps. Will these limits actually minimize price distortions or curb excessive speculation? Will they serve to prevent price spikes? I remain to be convinced of the first and in response to the second question I am certain they will not. Looking back on the 2007 and 2008 spikes in global food prices should remind us that position limits will not prevent price spikes.
Risk Management Requirements for DCOs
I don’t believe in letting the perfect become the enemy of the good. With that in mind, we have a rule proposal before us today that strikes the delicate balance between providing the fair and open access to clearing organizations, which is required under the Dodd-Frank Act, and maintaining strong standards for clearing members.
I do have some serious concerns about this rule. This rule has new requirements that will likely change some clearing organizations’ models regarding customer margining that will make it “too costly to clear.” The rule requires gross margining of customer accounts, and clearing members report gross positions down to the beneficial owner level to the DCO. The rule also contains limitations on the permissible investment of all customer funds and assets invested by the clearing organization, which I have raised concerns with in previous rulemakings.
All in all, though, I believe in the importance of strong clearing organizations and in promoting competition and innovation, and I will be interested to hear from the market whether or not they think this rule does a good job of striking balance between seemingly divergent interests.
It’s understandable that we would want to have clearing organizations welcome into their fold additional members to help bear that collective weight. There can be strength in numbers. At the same time, because every clearing member is exposed to the risk another poses to the group, it is understandable that clearing organizations would want to have standards in place that provide for a strong membership. As a result, I will be supporting this rule proposal, but strongly encourage commenters with concerns to give a voice to them by submitting their views.
I would like thank Sarah Josephson, Riva Adriance, Phyllis Dietz, John Lawton, and all of their teams for their hard work. I’d also like to thank the position limit team headed up on Bruce Fekrat and Steve Sherrod.
I have the greatest aspirations for the Commission’s ability to complete these rulemakings in a manner that strikes an appropriate balance between Congressional intent and the needs of market participants be they end users, swap dealers, hedgers, or speculators. It is important to keep things simple, cut away all the layers and provide a clear vision for the future of the derivatives markets.
Thomas Jefferson said that, “History, in general, only informs of us what bad government is.” In ten years, I’d hate to look back on this year of rulemaking and find that we have confirmed Thomas Jefferson’s worst fears.
Last Updated: January 18, 2011