March 30, 2012
Good afternoon, thank you Richard for that kind introduction. I’d also like to thank the Agribusiness Club of Washington for inviting me to speak today.
Farmers, ranchers, producers, processors and packers all rely on futures and swaps markets to lock in the price of a commodity and manage risk. The futures and swaps markets help them to focus on what they do best – producing food and fiber and other products for the nation.
The Commodity Futures Trading Commission (CFTC) and its predecessor agencies have regulated derivatives since the 1920s. The first derivatives – called futures – began trading at the time of the Civil War, when grain merchants came together and created this new marketplace. It took nearly 60 years until Congress first regulated the futures markets. President Franklin Roosevelt and Congress significantly strengthened this regulatory regime with the passage of the Commodity Exchange Act in 1936. Our great economic success as a nation has been, in part, due to the important financial reforms of the 1930s that brought transparency, openness and competition to the futures and securities markets and protected the public against fraud, manipulation and other abuses. These commonsense rules of the road have benefitted the public for decades.
While in the early days the markets were dominated by producers and processors, over time, the makeup of these markets has shifted dramatically. Financial firms and speculators now make up the vast majority of these markets. In Chicago Board of Trade wheat contracts, end-users make up about 10 percent of the long and 30 percent of the short positions – meaning at least 70 percent of this market consists of financial interests. End-users make up about 10 percent of the worldwide swaps marketplace. Though end-users represent a small part of the overall markets, it is critical that the CFTC protect the farmers, producers and merchants.
In 2008, the swaps market helped build risk on Wall Street that spilled over to the real economy. In response, Congress and the President passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), which expanded the CFTC’s mission to also oversee the previously unregulated swaps marketplace.
The Dodd-Frank Act’s financial reform brings to the swaps market the same principles of transparency, openness and competition that apply to the futures markets.
As it is the agricultural community and other end-users in the real economy – the non-financial side – that provide 94 percent of private sector jobs, it’s all the more important that the futures and swaps markets work for America’s job providers.
While the CFTC works to implement Dodd-Frank Act financial reforms, we have greatly benefited from important input from the agricultural community.
Farmers, ranchers, producers, processors and packers benefit from the ability to use agricultural swaps to hedge risk. At one of the first few meetings to consider final rules, the Commission authorized agricultural swap transactions and ensured the same rules will apply as those for other swaps transactions. The Dodd-Frank Act had prohibited these transactions – unless the CFTC authorized them. The public comments the CFTC received overwhelmingly supported treating agricultural swaps the same as other swaps.
The Commission also has proposed a rule regarding physical options, including those on agricultural commodities, and we have been consulting with the agricultural and energy communities as we work to finalize the rule.
Now let me turn to some specifics on what we’re doing to promote transparency, openness and competition in these markets and lower the risk of swaps to the rest of the economy.
The U.S. swaps market, remains today the largest dark pool in our financial markets.
The Dodd-Frank Act squarely addresses this by providing the public, for the first time, information on the pricing and volume of every swap transaction upon completion. Furthermore, end-users and other market participants all will benefit from seeing available bids and offers and gaining liquidity on transparent and competitive trading platforms.
The pre-trade transparency required for trades between financial firms on these platforms is only for transactions standard enough to be mandatorily cleared and small enough not to be considered a block trade. These transactions will benefit all others in the market by providing a reference price.
Farmers, ranchers and other end-users will get to see the pricing and volume of swap transactions on platforms, but get to choose whether or not to use the platforms – a win-win for end-users. Furthermore, end-users will continue to be able to rely on customized transactions to meet their particular needs, as well as to enter into large block trades.
The CFTC has completed key rules on transparency, including providing the daily valuation over the life of each swap – all cleared swaps to the public and uncleared swaps to each counterparty.
The Commission already has begun to receive position information for large traders in the swaps markets for agricultural, energy and metal products. CFTC staff has been spending a lot of time with the agricultural industry on implementing this rule, and we have extended relief to ensure there is adequate time to prepare for the new reporting requirement.
Furthermore, starting this fall, light will shine for the first time on the agricultural and energy swaps markets with the reporting – in real-time – both to the public and to regulators of nearly every swap transaction. And again, the CFTC was mindful of end-users when completing these rules, giving them more time to do their reporting.
Clearinghouses have lowered risk in the futures markets by standing between buyers and sellers of these contracts and guaranteeing each party against the failure of the other.
Dodd-Frank Act financial reform mandates that standard swaps between financial firms move into central clearing to significantly lower the risks that come from the highly interconnected financial system.
The CFTC completed rules establishing robust risk management requirements for derivatives clearing organizations. We finished a rule on the process for clearinghouses to submit swaps that may be mandated for central clearing.
Consistent with congressional intent, the CFTC is working to finalize a rule ensuring that end-users using swaps to hedge or mitigate commercial risk will not be required to bring swaps into central clearing. The Commission’s proposed rule on margin for swap dealers likewise provides that end-users will not have to post margin for uncleared swaps.
Swap Dealers and Market Integrity
Commonsense rules of the road mean regulating swap dealers to lower their risk to the rest of the economy. End-users and other market participants also need to be protected from fraud, manipulation and other abuses, as well as the burdens that may arise from excessive speculation.
The CFTC has begun finalizing reforms, including requiring swap dealers to establish sales practices that ensure they deal fairly with customers, provide balanced communications and disclose conflicts of interest before entering into a swap.
In addition, they will have to establish policies to manage risk, as well as put in place firewalls between a dealer’s trading, clearing and research operations.
We are working with the Securities and Exchange Commission (SEC) to further define the terms “swap” and “swap dealer.” We are taking into account all public comments, including those from farm credit institutions and agricultural cooperatives, and I believe we will be responsive.
By providing greater clarity on what it means to be a market maker as well as adjusting the de minimis threshold, I believe we will significantly address the many comments from end-users with regard to the further definition of a “swap dealer.” In addition, by addressing the many helpful comments regarding forward transactions for agricultural commodities, I believe we will help provide greater clarity to end-users as we finalize the further definition of “swap.”
Furthermore, the CFTC is working with participants in the electricity markets on possible exemptive orders for rural electric cooperatives, municipal public power providers and regional transmission organizations.
The Dodd-Frank Act also directed the CFTC to establish aggregate position limits for both futures and swaps, which the Commission completed in October 2011. These rules help promote market integrity by ensuring that markets reflect a broad set of views and are not affected by the concentrated position of any single speculator. The Commission staff spent a lot of time with the agricultural community prior to finalizing the rule. Its provisions regarding bona fide hedging exemptions benefited greatly from that input. We are continuing to work with commercial hedgers to provide further guidance on particular hedging transactions.
Segregation of customer funds is the core foundation of customer protection in the commodity futures and swaps markets. The CFTC is taking a number of steps in this area. First, the completed amendments to rule 1.25 regarding the investment of funds bring customers back to protections they had prior to exemptions the Commission granted between 2000 and 2005. Importantly, this prevents use of customer funds for in-house lending through repurchase agreements. Second, the Commission adopted an important customer protection enhancement that prevents clearing organizations from using the cleared swap collateral of non-defaulting, innocent customers to protect themselves and their clearing members. And third, starting this November, clearinghouses will have to collect margin on a gross basis and futures commission merchants no longer will be able to offset one customer’s collateral against another and then send only the net to the clearinghouse.
Beyond these steps, Commissioners and staff are getting a lot of feedback from market participants on additional customer protection enhancements. Earlier this month, staff held a two-day, public roundtable on this topic, and is actively seeking further public input through our website and further meetings. To the extent constructive reforms emerge from this outreach and review, staff will put forward recommendations to the Commission for consideration.
Confidence in the futures and swaps markets is dependent upon a well-funded regulator. The CFTC is a good investment of taxpayer dollars. This hardworking staff of 710 is just 10 percent more than what we had in the 1990s though the futures market has grown fivefold. The CFTC also will soon be responsible for the swaps market – eight times bigger than the futures market.
Picture the NFL expanding eightfold to play more than 100 football games in a weekend, leaving just one referee per game, and, in some cases, no referee. Imagine the mayhem on the field, the resulting injuries to players, and the loss of confidence fans would have in the integrity of the game.
Market participants depend on the credibility and transparency of well-regulated U.S. futures and swaps markets. Without sufficient funding for the CFTC, the agricultural community – and the nation – cannot be assured that the agency can adequately oversee these markets.
The CFTC is working hard to bring transparency, openness and competition to the swaps market. These reforms look out for end-users – farmers, ranchers, producers, processors and packers. They shift some of the information advantage from Wall Street, helping put the agricultural community on a level playing field with the big financial firms.
In finalizing our rules, the CFTC Commissioners and staff have had an unprecedented number of meetings with the public, international regulators, as well as other U.S. government agencies. I see my friend Farm Credit Administration Board Chairman Lee Strom in the crowd, and I want to thank you for working hand-in-hand with us on many aspects of these rules.
I will close by saying that I certainly miss my friend Mike Dunn. In his six years at the CFTC and his more than 25 years in government service, he served your community so well. This agency takes pride in its longstanding and strong working relationship with the agricultural community. This summer, I look forward to convening the Agricultural Advisory Committee, which Mike chaired.
Thank you for inviting me today, and I’d be happy to take questions.
Last Updated: March 30, 2012