March 14, 2017
Thank you. It is a pleasure to be here with you all to chat about some of the key issues facing the futures and swaps markets and the steps that the CFTC has taken to address them. It is my hope that many of these subjects will be of interest to you. After all, as we are all increasingly learning, the problems that one country’s markets face are rarely confined to just that country. Instead, market regulation is increasingly something that requires communication and agreement between different nations or even broad-based multilateral agreements to be done effectively.
First, as you all know, our markets have been transformed by the rise of electronic and algorithmic trading. According to our staff, algorithmic trading first accounted for 74% of orders in 2015 and 76% in 2016, and accounted for 64% of total trading volume in 2015 and 68% in 2016. Automated trading is continuing to become an ever larger part of our markets, and there is no sign of this trend abating. There is therefore a clear need for the CFTC to provide regulatory guidance and some common-sense regulations on automated trading. In response to these changes, the CFTC released a proposed regulation that would update our regulations for a world where the vast majority of trades are electronic or even algorithmic. This regulation, known as Regulation AT, was first released in late 2015 and was updated late last year. I believe we have largely struck a good balance between ensuring that algorithmic trading will not pose systemic risks to the markets while also allowing for innovation in this space to continue.
While the regulation is complicated, and I would not recommend anyone here use it as beach reading, there are a few points I would like to flag. Under this proposal, firms that make use of Direct Electronic Access (DEA) to connect to our markets will not automatically have to register. Instead, only those firms which use DEA and also have an average of 20,000 or more trades each day over a six month period will be required to register.1 It only seems appropriate that the firms responsible for a substantial portion of trades in our markets should have heightened regulatory requirements than small firms only entering a handful of trades a day. Second, our proposal requires that all electronic trading, algorithmic as well as non-algorithmic, will have two separate layers of pre-trade risk controls on it, with one level provided by the designated contract market and the other provided by either the algorithmic trader itself or its futures commission merchant. We are still receiving comments on this updated proposal for a few more months, and it is my hope that we can finalize this rule later this year.
Ultimately, algorithmic trading is an international enterprise. With many trades crossing international boundaries and investors now able to trade on a U.S. stock exchange from just about anywhere in the world, we need strong, consistent regulations around the world if we want to effectively police our markets. If you are considering how to craft regulations on algorithmic trading, I encourage you to take a look at what we have proposed.
Unfortunately, cyber breaches have become non-rare occurrences as it seems like every month a new cyber breach is reported. Here in the United States, it is safe to say that this issue has never been more universally discussed than it has been in recent months. I am therefore very happy that we have already finalized a rule to enhance the established cyber safeguards in place for many of our registrants. Key market participants will have to comply with five types of cybersecurity testing requirements. The testing requirements are vulnerability testing, penetration testing, controls testing, security incident response plan testing and enterprise technology risk assessments. While these rules may sound complex, they are based on common sense. Here again, however, we are in need of international cooperation and strong international standards.
That said, while I believe our current rules are strong, they could be improved. In fact, given recent events, I am beginning to wonder if we already need to do more to both push large entities to encourage greater innovation and to require that someone provide increased protection to end-users and smaller firms. Because of the interconnected nature of our financial system, our cybersecurity protections are only as strong as our weakest link. I hope that we can all work together to combat this growing threat, and I would urge you to reach out to our agency if we can be helpful to you on this issue.
To turn next to a topic that is especially near and dear to my heart, I would like to say a few brief words about the status of our governance rule. Under the Dodd-Frank Act, the CFTC was required to release a rulemaking to improve corporate governance at many of our registrants. In fact, the very first rule Dodd-Frank rule we proposed was on this subject back in late 2010. Unfortunately, this rulemaking has morphed from a rabbit into a tortoise. Over six years after first proposing this rule, it remains unfinished and is now one of the last handful of Dodd-Frank Rules that the CFTC has yet to complete.
I firmly believe that our failure to complete this rule has been a mistake. Based on my 30-plus years on Wall Street, I’ve learned that everything – communication, a culture of compliance, a focus on reasonable risk-taking, and an appreciation of mission – flows from governance. It’s not just another tool in our regulators’ toolkits. Better governance decreases systemic risk. Better governance increases profits. Better governance acts as a superstructure on which all other market and proscriptive regulations are built.
I have in the past laid out a number of ways our rulemaking on this subject might be improved, from encouraging greater diversity on boards and crafting qualitative and quantitative standards for directors to requiring testing of swap intermediaries and having SEFs turn over their enforcement duties to the National Futures Association or another self-regulatory organization.2 I continue to support this view, and I am optimistic that a strong governance regulation can be completed in the next year or two. After all, governance is not a partisan topic – regardless of your views, I believe there is reason to support rigorous governance rules. If you are concerned about excessive risk taking in board rooms or poor supervision of trading desks, better governance is a solution. And if you are worried about regulators being too aggressive with enforcement actions or fashioning overly prescriptive rules, better governance can both reduce the need for extremely proscriptive regulation and reduce the risk that a firm will ever run afoul of regulators. If your country wants to take steps to reduce rulebreaking and encourage better business outcomes for firms at the same time, I encourage you to consider updating your regulations on governance.
Finally, I would like to say a few brief words about position limits, a rulemaking I dubbed the eternal rulemaking near the beginning of my term. After two and a half years in this position, I have newfound appreciation for how this rulemaking remains unfinished. Under Dodd-Frank, the CFTC is required to issue regulations that limit the speculative positions that industry participants can take in certain key commodities, including crude oil, natural gas, silver, and wheat. The rulemaking was required as a means of preventing excessive speculation and market manipulation. Having reviewed many enforcement actions in my tenure, I remain steadfast in my belief that we need this rule. Our futures markets were originally created for end-users and they cannot exist without reasonable amounts of speculation providing liquidity. Yet, markets that are overly dominated by speculation endanger those very end-users who the markets were created for in the first place; worse, highly volatile markets sloshing about in a sea of speculative bets are markets that are easier targets for manipulative devices.
After all the late nights, lost weekends, and reams upon reams of comments that we have reviewed, I hope that the CFTC, industry participants, and interested observers can reach a compromise that allows us to finish this rulemaking in the near future in a way that protects consumers, investors, and end-users while also preserving the vitality of our markets. But whether we finish the rule or not, the need for a strong rule remains present. I remain optimistic we will get this done eventually, and even after our issues with this rulemaking, I encourage other regulators to consider instituting position limits on their markets.
Thank you again for the privilege of speaking to all of you. The events of the last year in our markets, politics, and international affairs have only underscored for me how important events like these are. While we may hail from many different countries, we are all linked together via our financial markets. Events in Asia and Europe do not merely affect Asian or European markets, they also ripple back to our markets. Similarly, what happens in the United States’ swap markets is typically relevant to Europe, Asia, everywhere. In some cases, as in the 2008 financial crisis, what begins in one country can spread to the point that becomes a paramount concern to the entire world.
When faced with such massive problems, the best hope we have for addressing them or even mitigating them is communication. I hope that my fellow Commissioners and I have done a good job to improve relations with all of you, but we can always do more. When you see a problem happening, I encourage you to reach out and see if we can help. Only together can we ensure that the markets and investors of each of our different countries are stable, efficient, fair, and safe. Thank you.
1 Supplemental Notice of Proposed Rulemaking on Regulation on Automated Trading at 29, 215.
Last Updated: March 14, 2017