April 5, 2017
Thank you for the kind introduction and good evening everyone. It is a pleasure to be here at the Eurofi High Level Seminar 2017. I attended the conference last year in Amsterdam, and found it so informative and engaging that I insisted on returning this year. Eurofi is a very important conference generally, but especially given recent unexpected events, it presents an opportune time for dialogue not only between European regulators and market participants, but also for those of us across the pond as well.
As a Commissioner at the Commodity Futures Trading Commission (CFTC), I am responsible for the policy decisions for the futures markets as well as the majority of the $400 trillion swaps market, including interest rate swaps, commodity swaps, and credit default swaps. Thus, it is from the vantage point of a market regulator of the vast, diverse and global U.S. derivatives markets that I address you today to answer the question: What future for global regulation of financial markets? There are three areas in which I think we, as regulators, need to cooperate, and where possible, harmonize, in order to best support our financial markets in the future: (1) market data; (2) enforcement; and (3) clearing. Please note that the views I express today are my own, and not necessarily those of my fellow Commissioner, Acting Chairman Giancarlo, or the Commission staff.
One area in which we need harmonization, and not fragmentation, is in the exchange of market data. At the Pittsburgh meeting of the G-20 in 2009, one of the fundamental goals that international regulators agreed upon, in the midst of the 2008 crisis, was that all swaps should be reported. In the U.S., as in many of your jurisdictions, under our current rules, all swaps transactions, whether cleared or uncleared, must be reported to a trade repository. This information is then aggregated and sorted, so that we have transparency into the markets under our purview. This gives us a great view into the markets, but not a complete one. The derivatives markets are global markets. Thus, in order for any regulator to properly police them, we need to understand them from a global perspective. That is why we need to remove the regulatory barriers to data sharing across jurisdictions for the purpose of effective market oversight. It is vitally important that we work together to achieve comprehensive and robust data harmonization.
I certainly understand the concerns about privacy surrounding data sharing. But there are other concerns that are equally troubling, namely, the prevention of another crisis like the one we endured in 2008. What tradeoffs are worth preventing another devastating economic crisis? The actual initiation of the crisis – the collapse of the U.S. housing market – certainly caused a serious economic convulsion, but what greatly magnified the devastation of this crisis was that we did not understand the underlying weaknesses of our markets, particularly the derivatives markets. We did not know the extent of our market participants’ exposure to derivatives, or their degree of under-collateralization. We thought we knew our markets, but we had no idea what they were really like. We thought we were in a house made of bricks, when it was actually made of straw; a reality we only understood after the storm came. We cannot afford to make that mistake again. We need a much more realistic picture of the markets we oversee. For that we need data, all of the data; and in order to achieve that, we have to work together.
Sharing data is also essential for analyzing market risk. For example, at the CFTC, we use margin, as one indication of risk. We regularly review the amount of margin outstanding, and analyze the likelihood that market counterparties can meet their margin requirements under a variety of past and hypothetical market movement scenarios.1 But without a full picture of the global market, we can get a skewed view of the actual risk profile of counterparties. We may think that a counterparty has a lot of one-way risk, when a full picture would reveal a much more balanced portfolio. The opposite is also true: we may have a false sense of security, when in fact there is cause for concern. Thus our ability to mitigate systemic risk is hampered by insufficient data; and so is yours. We need each other to address this.
Harmonization in Enforcement
Another area where harmonization is essential is in enforcement. As regulators, it is in our best interest to share information about potential bad actors that are moving from market to market harming customers, lessening efficiency and bringing otherwise functional markets into disrepute. It is all too easy today for a malfeasant in one jurisdiction, who is dismissed, to pick up and move to another jurisdiction and continue working. I call it the “whack-a-mole” problem. It is to everyone's benefit that these people are detected and prevented from harming other customers. This is not the moment to retreat or repeal the great strides we have achieved. With global regulatory coordination on enforcement, we can better achieve our purpose as regulators – to incentivize the formation of efficient, transparent, well-collateralized markets that are safe for counterparties. To do less, is to fail to do our jobs as protectors of our markets and of our citizens who rely upon them.
Another area where harmonization is critically important, and where the danger of fragmentation exists, is in that of clearing. One of the other lessons learned from the 2008 crisis, which was highlighted by the G-20 in 2009, was that well-regulated clearing can be a powerful tool to stem systemic risk. Unlike many other parts of our economies, clearinghouses performed exceptionally well during the crisis. Why are clearinghouses so important in countering systemic risk? Because clearinghouses serve as a vital means to appropriately manage collateral requirements while also providing regulators with clear, timely visibility into these markets. Clearing thus shines much needed light on a previously dark sector of the market.
We of course need to stay vigilant about ensuring that our clearinghouses are managing risk effectively. November of last year, an advisory committee at the CFTC that I sponsor called the Market Risk Advisory Committee made recommendations to strengthen the risk management of clearinghouses. This diverse group of market participants including clearinghouses, banks, asset managers, and end-users just to name a few, highlighted several default management issues, including taking into consideration CCPs’ such as the interdependence between CCPs and their clearing members and the challenges to porting customer accounts of a failed clearing member. 2
Regarding market fragmentation, in the U.S., we have also been following the discussion in Europe about segmenting clearing based on location, because of oversight concerns. How have we at the CFTC dealt with this issue of clearing for U.S. customers occurring outside the U.S.? We recognize that, as members of a global market place, our U.S. customers need to clear a variety of products all over the world. We want our U.S. citizens to have safe and sound clearinghouses around the world that they can use. In order to do that, we register two types of clearing-based financial market infrastructures: (1) Derivatives Clearing Organizations (DCOs) and (2) exempt DCOs. Any clearinghouse that wants to allow for both customer clearing, as well as proprietary clearing, for U.S. customers must be a registered DCO with us. They must demonstrate that they are a viable and well-managed organization that has, among other things, sufficient financial resources, effective system safeguards, robust margin methodology, and a primary regulator with which we have a strong relationship. And we must also be able to access the data that we need for oversight without hindrance, and make onsite visits as needed. As long as a clearinghouse is able to demonstrate that it meets these, and other, rigorous standards, they can serve U.S. customers, regardless of their location.
And we also register exempt DCOs. There are non-U.S. clearinghouses that only wish to clear for their proprietary accounts and for whom U.S. customers comprise a small percentage of their overall business. Such a clearinghouse is eligible for registration as an exempt DCO. In order to achieve exempt DCO status, the clearinghouse largely has to demonstrate that they are managed by a competent primary regulator within an effective and comparable regulatory regime. Moreover, while we require that exempt DCOs provide us with sufficient data to monitor the extent and nature of the U.S. business at that clearinghouse, we largely rely on the primary regulator for oversight.
Importantly, we do not insist that only U.S. entities handle U.S.-denominated products. In fact, the clearinghouse that serves most U.S. interest rates customers is outside of the U.S. But that does not concern us, because our oversight and communication with that clearinghouse is robust and we have a great dialogue with its primary regulators. Moreover, as regulators, we do not believe that it is in our purview to determine where the market takes its business – this is a global market so the solutions will be all over the globe.
With this paradigm, we are able to have the information needed to engage in the appropriate oversight of these clearinghouses all over the world. For non-U.S. clearinghouses that do significant U.S. business, we have considerable oversight. And for those that have much less impact on U.S. business, we have less so. But in both cases we have the means to meet our regulatory goals. Moreover, providing U.S. customers with the ability to centralize multi-jurisdictional clearing provides the opportunity for sensible, well developed, risk-based cross-margining. This frees up funds for investment in growth and innovation in our economy.
While on the subject of clearing, I cannot help but mention that while in the U.S. we have been successful in bringing widely used interest rate and credit default instruments, and other instruments, onto clearing, the gains that we have made are at risk. The application of a capital charge to the segregated funds set aside to secure cleared products is reducing the appeal and viability of clearing. While I understand that capital plays an important role in financial stability, applying a capital penalty on clearing is counterproductive, and risks driving many of our now, highly transparent transactions back into the darkness. We need to address this. It is clearly an unintended consequence when two sets of regulations, both of which are meant to buttress our financial system, clash. I am hopeful that ongoing discussions with banking regulators will address this unfortunate outcome.
In sum, regulatory harmonization is an imperative today. Our times are turbulent. And in the midst of these rapid changes, the electorate, in several jurisdictions, has responded in drastic and surprising ways. As regulators, we cannot control, nor predict, the political process. But, we can help to maintain stability regardless of the political turbulence. But to do so, we not get swept up in the emotionalism of the time. We should not punish markets and customers for the unpredictable decisions of a beleaguered electorate. Regulatory fragmentation does not help anyone; systemic risk has no platform or party. When a customer loses his life savings, it does not matter if he is a Republican or Democrat.
So let’s work together on the front end to achieve the kind of reform from which all our economies would benefit. Let’s avoid unnecessary and time consuming squabbles on the back end over matters such as equivalence. With our mutual legislative acts, we have all endeavored to create a transparent, functioning market with strong foundations. Let us not risk all that we have built, and continue to build, by getting swept up in a furor that was not of our making. Let us instead, stay the course – focus on building strong, harmonized, global regulation that provides our economies with safe institutions as well as the capital necessary for growth and innovation.
1 See e.g., "CFTC Staff Issues Results of Supervisory Stress Test of Clearinghouses," (Nov. 16, 2016), available at http://www.cftc.gov/PressRoom/PressReleases/pr7483-16. And the Commission is actively engaged in discussions over appropriate recovery and resolution infrastructures for clearinghouses. See e.g., “CFTC Staff Issues Guidance to Clearinghouses on Recovery Plans and Wind-Down Plans,” (July 21, 2016), available at http://www.cftc.gov/PressRoom/PressReleases/pr7409-16.
2 See “Market Risk Advisory Committee,” available at http://www.cftc.gov/About/CFTCCommittees/MarketRiskAdvisoryCommittee/index.htm.
Last Updated: April 5, 2017