April 30, 2013
Thank you. Thanks for the introduction and I appreciate the invitation from Craig (Goodman) and appreciate your service to our country for so many years as part of several administrations.
It’s good to be with you today at your Annual Restructuring Conference. I am so down with your theme, by the way: “How to serve the public interest using competitive markets.” It may be a shocker for you, but not everybody that comes to see me at CFTC has the public interest in mind—surprise, surprise, surprise! In other remarks, I’ve spoken about the need for a culture shift in many corporate boardrooms and suggested that profit and loss statements shouldn’t be the only thing they think about. To some, it might seem like heresy, but there is an essential place in corporate boardrooms and executive suites for considering the greater good, the consumer, and the public interest. That’s all on that topic because you all clearly get it. You go! Let me make a toast: Here’s to hoping more aspire to be like you and that you keep going and going and going. Cheers.
And on that going and going note, one thing I’ve long admired about folks like you is the way you use markets as they were originally intended—to mitigate risk and help with price discovery. You need to because like the Energizer Bunny, you have to keep going and going and going or your customers will suffer.
In other words, that’s part of what makes you so reliable—you! It’s hard to hedge risk on just about anything, but when you’re hedging based upon how hot a summer you think it will be or tweaking your positions based upon the afternoon wind speed, that’s truly tough. It is beyond challenging. Maybe you guys can all do it fairly seamlessly, but it sure looks impressive from the outside. And that’s for people who are looking. I don’t think most folks have anywhere near a visual about how difficult that is to do. You are very reliable because of your efforts and you simply keep going and going and going.
What about us in government, people like me and my organization? Are we as reliable as we should be? Think back to 2008 when an irresponsible Wall Street and unreliable regulators stood by and watched the whole economy collapse. Nine million people lost their jobs; many more their homes. Something had to be done and it was done in the form of Dodd-Frank. That law gives regulators the tools to be reliable at keeping Wall Street responsible. It’s not all implemented yet, but we are trying. We are going and going and going. Eventually, we will get it done.
So today, let’s talk about why that—getting Dodd-Frank done—is categorically important.
Here’s one example: The “financialization” of commodity markets by traders I call Massive Passives. These guys, at times, are impacting markets and your ability to properly hedge your risk. Between 2005 and 2008 we saw roughly $200 billion come into the regulated futures markets in the U.S.—$200 billion! And that’s just what we know about. At that time, we didn’t have the access to see everything going on in unregulated over-the-counter markets. With Dodd-Frank, we do and we have greater transparency. But, what we’ve seen isn’t all that pretty.
So, where’d this $200 billion-with-“B” come from? Say a pension fund wanted to diversify into commodities. That’s generally OK, right? But the type of trading that they and exchange traded funds and mutual funds and other managed money do (not all the time, but generally) is different than what speculators used to do. Instead of getting in and out of markets, maybe based upon a drought or other natural disaster, or in the energy markets getting in or out related to the weather, the driving season, OPEC or a refinery breakdown, these very large funds put money in the markets and park it. They are relatively price insensitive. They don’t get in or out of the market because prices change a little here or there. They are in it for the longer haul. They invest more like folks invest in the stock markets.
Back in the day, perhaps a Dad said to his kids:
Sonny Boy, Girly Sue, let me explain investing to you
As a stock holder, when we get older
you’ll recall this chat about stock this and stock that
You’ll remember I said with a grin
that these shares of….Energizer Holdings or something akin,
will be worth something then
So, we’re gonna hold onto these bad boys
We are going to keep going and going and going with them
Someday, when then arrives, we’ll be rich. It will change our lives!
That’s how wealth derives
So, the Massive Passives took a tried and true strategy for stocks and used it in futures. I’m certainly not suggesting that they should be kicked out of our markets—no, no, no. Nevertheless, this type of trading strategy is a concern.
Massive Passives are a concern because too much concentration in markets can influence prices. Now, many people would say that any liquidity is good liquidity. But, are we sure? There are times when there is so much Massive Passive liquidity on the buy side—those going long and staying long—that prices cannot be based on the fundamentals of supply and demand. I’ve seen in energy markets 12 longs for every short. But you folks don’t need to see that data to know all this. You’ve seen it firsthand. You’ve felt it, smelled it and tasted it. You know it: 2008 crude with a rude tude that tattooed many companies, end users and consumers alike.
Crude went from just under $100 a barrel all the way up to the mid-140s and then all the way back down to 30 bucks. Supply and demand fundamentals do all of that? Oh no they didn’t! You know they didn’t.
By the way, in 2008 when the crude price dropped late in the year, it was when the economy was going someplace in a hand basket. Even the Massive Passives weren’t so passive. And, if they exit a market en masse, they can contribute significantly to price declines. We have witnessed some reciprocal downturns even recently—cough cough—precious metals, for example.
It hasn’t gotten better since ’08. We’ve seen well over the amount of speculation we had in 2008 at various times since then. With such large concentrations of market participants, it continues to raise the concern about how prices can be contorted. That’s not good for the traditional market participants like you, nor for consumers or the economy.
In response to what was going on in 2008, Congress instructed us as part of Dodd-Frank to put in place speculative position limits, limiting the position any one trader could have in a particular commodity. OK, the limits aren’t in place yet. We got lobbied, pressured, sued and screwed. But, to paraphrase, the reports of our death have been greatly exaggerated. We are going and going and going to get limits in place…period. Congress wanted them; President Obama wants them; traditional market participants want them and I want them. We have appealed a court decision and at the same time we are working on yet another position limits rule that will address the issues raised by the court. If we do not meet and approve that rule in May or June, it would surprise, surprise, surprise the daylights out of me. Not to do so would be irresponsible. It’d be a shocker for me.
The bottom line is that you guys, end-users, should be able to hedge without getting crushed by the Massive Passives. And, you shouldn’t have to worry about another potential threat to your hedging: high frequency traders—those traders I have termed “cheetahs” because they (like the cats) are so fast, fast, fast. And guess what? These high frequency trading cheetahs also keep going and going and going. Yepper, they are in markets 24-7-365 trying to scoop up micro dollars in milliseconds. End-users shouldn’t be easy prey that can be mauled by the cheetahs.
Research that we have done suggests the cheetahs make the most when they trade with smaller traders, but they still make plenty when they trade with fundamental traders. That’s some of you folks—end users. Are these cats the new middlemen? Many end users have told me so. And guess what? They aren’t even required to be registered. They aren’t required to test their programs before they get put into the live production environments (the markets), and they aren’t required to have kill switches in case their cheetah programs go feral.
So, we need to ensure that you guys, end-users aren’t stifled in your ability to hedge by the Massive Passives or the cheetahs.
The End-User Bill of Rights
Finally, I don’t have to tell you that one group that got hurt in the economic meltdown was end-users. That’s part of the reason that as we look at implementing Dodd-Frank and look to see what should be done with the cheetahs, we go forward in a thoughtful manner for end-users. So that’s why a month ago, I proposed an “End-User Bill of Rights,” and I want to spend my final few minutes on that today.
Here is the beastly bottom line: The futures and swaps markets wouldn't exist without end-users. The primary public benefit of derivative markets is that they provide end-users risk management opportunities that, in turn, allow them to more easily fund operations and investments and thereby generate economic growth. The ability of end-users to fund their operations is directly related to the prices paid by consumers and the overall well-being of our economy, and as you guys say—the public interest. It is that greater good we spoke about earlier. So, protecting the end-users is akin to protecting the every-day consumer. The End-User Bill of Rights therefore focuses on what should be the inalienable rights of end-users. I won’t walk through all ten, but let me hit a few highlights. Then, we also have a handout here of all ten of them and more detail if you’d like.
1. Right to reasonable Dodd-Frank implementation. Dodd-Frank needs to be implemented and needs to be implemented quickly, but that does not mean it should be done chaotically. We need to be sensible and need to provide answers to all questions before we get all regulator on folks with talk of any action.
In that same vein
2. Right to legal certainty. The Commission needs to provide the market as much legal certainty as possible as we move through a challenging implementation period. End-users and other market participants should have little doubt as to the status of their activities and the Commission and staff should respond thoughtfully and diligently to requests for legal certainty.
And the last one I’ll mention is…
3. Right to be heard. Many end-users are not used to having their swaps activity subject to CFTC regulation. During and after Dodd-Frank implementation, we need a venue for end-users to air those concerns. Some of you folks have never ever been regulated by the CFTC. We need to understand what you do better and you need to become better acquainted with us. So, let’s do lunch (kidding). Here’s a better idea. Let’s establish at the CFTC an End-User Advisory Committee (EUAC). The EUAC could be a good mix of folks from the end-user community that meets with the Commission on a regularized basis. We have these advisory committees for other areas, and I think it is time for one that focusses on end-users, particularly.
I could keep going and going, but I need to wrap this thing.
Conclusion: Keep Going and Going and Going
So those are just some examples of what we as a Commission are doing to try to bring reliability to these important markets we regulate, and, to ensure that they are fair, and that they are competitive. We’re going and going and going. And we want to keep listening and listening and listening to folks like you who know something about reliability, public interest and competitive markets. You are the ones who can help us get the regulations right.
My message is: We need to be able to adjust to the changing market world we live in. That means working with you folks, getting a handle on the Massive Passives and the cheetahs, and getting all the Dodd-Frank rules in place in an appropriate manner.
Last Updated: April 30, 2013