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  • “Impacts of the Financial Crisis on the Derivatives Markets”

    Remarks of Commissioner Michael V. Dunn at the Bürgenstock Regulators’ Meeting - Interlaken, Switzerland

    9am-12pm, Wednesday, September 9, 2009

    Thank you. I am happy to be here in Interlaken today to address this distinguished group of regulators. At our meeting last year, we were faced with tremendous distress in the financial markets that we sought to deal with. This year, our task is no less daunting, and finding sound regulatory solutions to the problems we face is just as important. At the CFTC, we are led by a new chairman, Gary Gensler, who was appointed by President Obama to take the reins and was confirmed by the US Senate in May.

    The United States is moving quickly to deliver comprehensive oversight of OTC derivatives markets, and particularly to ensure that all OTC derivatives markets are regulated, not just those that make headlines in the news. In June, the US administration presented a White Paper discussing proposals in this area. After nearly two months of consultation with regulators, Congress, industry representatives and our fellow regulators in other nations, the administration presented Congress with concrete draft legislation on OTC derivatives regulation, based on four simple objectives.

    • First, all OTC derivatives markets must be regulated.

    • Second, all dealers and major participants in these markets must also be regulated.

    • Third, regulators must work under clear authority to prevent market manipulation, fraud and other market abuses.

    • Finally, the draft legislation seeks to protect all investors, especially those that have less experience in and knowledge about financial markets.

    The CFTC, led by Chairman Gary Gensler, has actively participated in the formation of this draft legislation.


    Before I go into detail on each of these objectives, let me address the unique jurisdictional issues that we face in the United States. As you know, the CFTC is the principal regulator in the US for all transactions dealing with futures and options on futures, while the SEC is the primarily regulator for our securities markets. Despite this division, under the draft legislation, the CFTC and the SEC will be working jointly on all regulations and interpretations that affect critical elements of derivatives regulation, so that, at a high level, there is a uniform approach to OTC derivatives regulation. Where we can’t agree on the minute details of specific regulations, the Treasury Department will step in with its own interpretation, until agreement is reached. This will limit the ability of market participants to shop for the regulator that may leave them under-regulated and more likely to contribute to systemic risk.

    • Beyond this joint approach to regulation, however, the legislation describes what markets and participants the CFTC will regulate and what markets and participants the SEC will regulate.

    • The legislation removes limitations on the CFTC’s jurisdiction with respect to certain derivatives transactions, including swap transactions between “eligible contract participants.”

    • Generally speaking, the SEC will have jurisdiction over security-based swaps. That is, swaps based on a single security, narrow-based security indices, or on the occurrence of an event relating to a single issuer of a security or narrow-based security index, will be subject to the jurisdiction of the SEC.

    • All other swaps, with some exception, will be subject to the CFTC’s jurisdiction. This includes, for example, commodity swaps, credit default swaps, interest rate swaps, currency swaps, and more, so long as they are not also security-based swaps.

    • Transactions for non-financial commodities for deferred shipment that are physically-settled, options subject to the SEC’s jurisdiction, foreign exchange swaps and forwards, transactions in which the counterparty is the US government or agency, or security-based swaps as described above would be excluded from the definition of swaps under the legislation.

    • Identified banking products will be regulated by the federal banking agencies, not the CFTC or SEC, unless the regulating bank authority determines that a product has been structured so as to evade regulation by the CFTC or SEC.

    Objective 1 – Regulate all OTC Derivatives Markets

    • All standardized OTC derivatives must be centrally cleared by a registered derivatives clearing organization, a DCO, and traded on a designated contract market, a DCM, or in some cases, a registered alternative swap execution facility. The CFTC and SEC will jointly adopt regulations governing entities registered as DCOs for swaps with the CFTC, and clearing agencies for security-based swaps with the SEC.

    • Recognizing that a certain amount of flexibility may be required, the CFTC may exempt a clearing house from registering with the CFTC if it is subject to comparable, comprehensive supervision and regulation by another regulator, such as the SEC or a banking agency.

    • The CFTC and the SEC will jointly define the term “standardized,” based on criteria specified in the legislation. If a clearinghouse accepts a swap transaction for clearing, then there is a presumption that the swap is standardized.

    • Moreover, the CFTC and the SEC will jointly prescribe regulations or issue interpretations as necessary to prevent market participants from evading these requirements. Parties who enter into non-standardized swaps must still report such transactions, either to a swap repository or directly to the CFTC. A swap repository, which will accept, maintain and make available swap data as prescribed by the CFTC, must register with the CFTC and be open to CFTC inspection and examination. The CFTC and SEC will jointly adopt uniform regulations governing entities registered as swap repositories with the CFTC or security-based swap repositories with the SEC. Any person who enters into a swap that is not cleared by a DCO or reported to a swap repository is subject to reporting and recordkeeping requirements.

    • The shift of more OTC derivatives to centralized clearing and exchange trading will be incentivized through the enforcement of higher capital requirements and higher margin requirements for non-standardized derivatives.

    • Transparency for all OTC derivatives will be greatly enhanced through requirements for confidential reporting to regulatory agencies of all OTC derivatives transactions and access to the public of aggregate data on open positions and trading volumes, to be conducted either by the CFTC or a clearing house or swap repository designated by the CFTC.

    Objective 2 – Regulate all OTC Derivatives Dealers and Major Market Participants

    • All OTC derivatives dealers and any firms that take large positions in OTC derivatives markets, dubbed major swap participants, must be regulated. These swap dealers and major swap participants will be required to register with the CFTC.

    • The CFTC and SEC will jointly adopt rules for entities that register with the CFTC as swap dealers or major swap participants or register with the SEC as security-based swap dealers and major security-based swap participants.

    • Banks will be subject to regulation by federal banking agencies, while the CFTC and the SEC will share regulatory supervision over all non-bank swap dealers and other major market participants.

    • Strict capital and margin requirements will be applied to all regulated entities.

    • The CFTC and the SEC will enforce business conduct, reporting and record-keeping rules for all regulated entities.

    Objective 3 – Prevent Market Manipulation, Fraud, and other Market Abuses

    • Both the CFTC and the SEC will have unimpeded authority to deter market manipulation and other market abuses in the OTC derivatives markets.

    • Both the CFTC and the SEC will have the authority to set position limits and large trader reporting requirements on OTC derivatives that perform a significant price discovery function with respect to regulated markets.

    o In December 2008, the CFTC issued proposed rules for public comment that would essentially have done what the legislation now calls for. The proposed rules would have revised information-submission requirements applicable to exempt commercial markets (ECMs), established procedures and standards by which the CFTC could determine that an ECM contract performs a significant price discovery function, provided guidance with respect to compliance with the nine core principles for ECMs with SPDCs, and amended existing regulations applicable to registered entities in order to clarify that such regulations would become applicable to ECMs with SPDCs.

    o Before the Commission acts to set strict limits on exchange traded contracts, we must have the authority to set limits in OTC contracts as well or traders will go from the transparent markets to less-transparent venues where there are no limits.

    o We must work internationally to harmonize speculative position limits, so that we do not allow for regulatory arbitrage. Unless harmonized, position limits will only serve to shift trading to other forums.

    • The CFTC will be authorized to adopt regulations requiring registration by, and prescribing registration requirements for, foreign boards of trade that provide members or other participants located in the US direct foreign access to the foreign board of trade’s electronic trading and order matching system.

    Objective 4 – Protect Less-experienced Investors

    • The scope of investors eligible to participate in OTC derivatives markets will be tightened, to better protect individuals who are less experienced in the market, and municipalities, who stand most vulnerable in the short term to market disruptions.

    Last Updated: June 10, 2010

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