October 1, 2012
Good afternoon, Lord Hoffman, I appreciate that kind introduction. I would like to thank the Financial Markets Law Committee for the invitation to speak today.
You’ve asked how the legal and regulatory regimes of countries around the globe can best coordinate and how they should interface, in particular when financial institutions operate outside of their home country’s borders.
I’m going to do my best to answer your question most directly at the end of my remarks. But if you’ll first allow me the opportunity to address your question in the context of financial reform and the ongoing matters regarding the London Interbank Offered Rate (LIBOR).
It wasn’t long ago that the financial meltdown in the United States spread around the globe. Both the financial system and the financial regulatory system failed in 2008.
It’s important to remember the human cost of the financial crisis. In our country eight million jobs were lost, millions of families lost their homes, and thousands of businesses folded. Across Europe, with your ongoing debt crisis, an even greater number of families are struggling.
The over-the-counter derivatives or swaps market, which was basically not regulated in the United States, Europe or Japan, helped to contribute to the crisis.
In 2009, President Obama and the G-20 leaders meeting in Pittsburgh came together with a new consensus that swaps should now be brought into the light through transparency and oversight.
Over the last three years, each of the major market jurisdictions has been coordinating on implementing these critical financial reforms to make the swaps market safer for the public.
The Commodity Futures Trading Commission (CFTC) has consistently engaged with our international counterparts through bilateral and multilateral discussions to promote robust and consistent swaps market reform.
We’ve worked with numerous authorities here in Europe, in particular the Financial Services Authority (FSA) in London, the European Securities and Markets Authority (ESMA) in Paris, and the European Commission in Brussels. We’re also working with international standard setting bodies to develop and implement international standards for the swaps market. While we’re bound to have some differences, I believe we’ve made significant progress on aligning our approach to over-the-counter derivatives reform.
Foremost in answer to your question, with regard to financial market oversight, it’s preferred if we can align with the same laws and rules. This is what we’ve attempted to do these last three years with this significant cross-border consultation.
Global Progress on Swaps Market Reform
In 2010, the U.S. Congress passed the historic Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Europe, Japan and the largest provinces in Canada have also made substantial legislative progress on reform.
To date, the CFTC has completed 39 rules, and substantive swaps market reform is now in sight.
Bright lights of transparency will begin to shine on the swaps market. By the New Year, as swap dealers begin registering, I envision robust real-time public reporting and reporting to data repositories of interest rate and credit default swap (CDS) indices. Such reporting begins for energy and other physical commodity swaps shortly thereafter.
Once registered, swap dealers also will implement business conduct standards that will lower their risk to the economy and promote confidence in their integrity.
Regarding swaps that are part of an exchange-of-futures-for-swaps transaction, commonly called EFS, they are swaps, as the term indicates, and thus come under the Dodd-Frank Act and the CFTC’s various completed swaps rules.
Looking forward, we’re closing in on completing our swaps market reform rule set. Before turning to international coordination on benchmark interest rates, I’d like to focus on four areas of reform yet to be completed: the clearing requirement, transparency rules, margin and the cross-border application of swaps market reform.
The Clearing Requirement
First, the Commission has made significant progress on bringing swaps into central clearing, which reduces the risk of the interconnected financial system. We’ve finalized and now clearinghouses are adopting risk management reforms, consistent with international standards.
In July, we embarked on the last step toward required clearing of standardized swaps. We put out to public consultation a proposal on clearing requirement determinations. They begin with standard interest rate swaps in U.S. dollars, euros, British pounds and Japanese yen, as well as a number of CDS indices, including North American and European corporate names.
As our Congress gave us 90 days to complete such determinations, the first set may be finalized as early as this month. This would lead to required clearing by swap dealers and the largest hedge funds as early as the end of January. Compliance would be phased in for other market participants through the summer of 2013.
This timing broadly aligns with both Japan and Europe. Just last week, ESMA published its technical standards for clearing, reporting and certain risk mitigation rules for adoption by the European Commission. Japan is expected to begin its clearing requirement this November.
Second, the CFTC is working on finalizing later this fall a set of rules promoting greater transparency. This includes rules on minimum block sizes, as well as trading platforms called swap execution facilities.
The more transparent a marketplace is to the public, the more efficient it is, the more liquid it is, and the more competitive it is. Reforms to bring such transparency and competition to the swaps market will significantly benefit non-financial and financial companies alike that use these products to hedge their risks.
The European and Japanese transparency legislative proposals, as well as initiatives well underway in other jurisdictions -- when fully implemented -- will further align international reform efforts and benefit the public.
In this regard, I am pleased that the Economics and Monetary Affairs Committee of the European Parliament took a significant step last week. It approved the transparency initiatives proposed in Markets in Financial Instruments Directive (MiFID) and Regulation (MiFIR).
Third, we are collaborating closely with Europe and internationally on a global approach to margin requirements for uncleared swaps. We are doing so through the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) whose consultative paper on margin closed just last week.
I would anticipate that the CFTC, in consultation with Europe, would take up the final margin rules toward the beginning of next year with the benefit of this international work.
Cross-Border Application of Swaps Market Reform
Lastly, the CFTC is working to finalize guidance on the cross-border application of Dodd-Frank swaps market reform, which relates to your question of how legal and regulatory regimes around the globe should interface.
The reality of modern finance is that large financial institutions set up hundreds, if not thousands, of “legal entities” around the globe. Many of these legal entities, however, are still highly connected back to their U.S. parent.
The lessons of the 2008 crisis and earlier have demonstrated that time and again financial transactions executed offshore by U.S. financial institutions can send risk straight back to the United States. It was true with the affiliates of AIG, Lehman Brothers, Citigroup and Bear Stearns. A decade earlier, it was true, as well, with the collapse of the hedge fund Long-Term Capital Management.
Recently, we were reminded once again of this interconnectedness by the CDS index products traded by JPMorgan Chase’s Chief Investment Office.
During a default or crisis, in particular, the risk that builds up outside our borders comes back to the United States.
For the American public to be protected, swaps market reform should cover transactions with U.S. overseas branches, overseas affiliates guaranteed by U.S. entities, and overseas affiliates operating as conduits for U.S. entities’ swaps activity.
In June, the Commission -- consulting closely with domestic and foreign regulators -- proposed guidance interpreting the cross-border application of the Dodd-Frank Act. In a separate release, the Commission proposed phased compliance for foreign swap dealers (including overseas affiliates of U.S. swap dealers) regarding certain requirements of Dodd-Frank swaps market reform.
Such phased compliance would enable market participants to comply with the Dodd-Frank Act in an orderly fashion. It would allow time for the CFTC, international regulators and market participants to continue coordinating on regulation of cross-border swaps activity. And it would allow for appropriate implementation of substituted compliance, or allowing market participants to comply with Dodd-Frank through comparable and comprehensive foreign regulatory requirements.
The CFTC has a consistent record of relying on comparable home country regulation where appropriate. We are very much committed to recognition regimes for swaps market reforms as well, where there are comparable and comprehensive requirements.
The CFTC also has had a long history of working with international regulators to coordinate oversight of cross-border entities. We have done so with regard to clearinghouses, futures commission merchants and foreign boards of trade. An example of this coordinated supervision includes our work with the FSA for the clearinghouses LCH.Clearnet and Ice Clear Europe.
Coordination on Barclays Case and LIBOR
Let me now turn to the close coordination between the CFTC, the FSA, and other international regulators on benchmark interest rates, including LIBOR.
We had a very strong working relationship with the FSA on the Barclays enforcement case. The CFTC, the FSA, IOSCO and other international entities are now coordinating on the broader review of benchmark interest rates, commodities and other indices, as well as next steps.
As international market participants and regulatory authorities move toward more reliable and honest benchmark interest rates, I believe it is critical that such rates rely upon observable transactions.
A rate that relies upon observable transactions is anchored by the reality of that price discovery.
A rate that relies upon observable transactions has a lit path to credibility.
A rate that relies upon observable transactions is less vulnerable to misconduct.
We can and should work to address LIBOR’s issues of governance and conflicts of interest. We also must recognize and address, however, the fundamental issue facing LIBOR and other similar benchmarks: the underlying market for unsecured interbank borrowing has largely diminished. Market data raises questions about the integrity of LIBOR today.
Martin Wheatley’s plan published last week is an important step forward to ensuring that the public has confidence in benchmark interest rates. As one of its recommendations, the Wheatley plan recommended significantly curtailing the number of currencies and maturities for LIBOR. Any such curtailment or a broader replacement of LIBOR would need an appropriate transition.
Mr. Wheatley and I have been asked to co-chair the IOSCO task force that will build on his plan and examine next steps on benchmark interest rates. We are having our first meeting in Madrid this week.
He and I are recommending that the IOSCO task force consider, among other things, issues market participants might confront when seeking to make a transition to a new or different benchmark and potential mechanisms to overcome those challenges. I look forward to broad global consultation on these critical matters.
Now, I’ll more directly address the topic of your conference.
Despite different cultures, political systems and financial systems, we've made significant progress on a coordinated international approach to swaps market reform and are collaborating closely on matters related to benchmark interest rates.
My philosophy is that we must continue this strong international coordination -- as we have through sharing policy documents and maintaining an open line of communication -- to implement comparable forms. Where possible, it’s best to have consistent reforms globally that promote transparency and lowering risk to the swaps market.
At the same time, we need to recognize there will be times when we’re unable to have exactly the same approach. This is inevitable given our different cultures and political systems.
Thus, the issue is -- what do we do when we have different rules?
Our laws tell us that when financial institutions operating outside the United States transmit risks directly into the United States through swap transactions with U.S. persons, such transactions should be regulated in the same manner as swap transactions within the United States.
In 2008, American taxpayers stood behind financial institutions that entered into swap transactions both in the United States and abroad.
Our approach to reform is to better protect the American public from risk that financial institutions can create abroad.
I thank you again for inviting me today, and I look forward to your questions.
Last Updated: October 1, 2012