October 23, 2012
Good Morning. Tim, I appreciate that kind introduction. I want to thank the Securities Industry and Financial Markets Association for the invitation to speak at today’s annual meeting.
I’d like to take a moment to go back to basics.
The role of finance and financial markets is quite important.
It is to allocate the American people’s money and investments to businesses looking to grow and families looking to borrow for their future.
It is to help price and allocate risk in our economy.
Finance works best when new participants are allowed unfettered access to markets and to information, and when prices are established transparently and free of fraud and manipulation.
Finance works best when its largest players are free to fail, and taxpayers and the government are not left with the bill – just as is expected in other parts of our free market economy.
In sum, the role of finance is to serve the rest of the economy.
As the financial system failed in 2008, the unregulated swaps market failed to meet these objectives.
The marketplace operated without the basic transparency and common-sense reforms that President Roosevelt and Congress put in place for the securities and futures markets in the 1930s.
Those historic reforms democratized our financial markets and have led to many decades of economic growth and innovation.
Eight million Americans lost their jobs as a result of the 2008 financial crisis. This then led to a new international consensus that transparency, oversight and competition must be brought to the swaps market.
Based on this new consensus, Congress and the President came together and passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), tasking the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) with this critical job.
Again, bringing it back to basics, the Dodd-Frank Act’s goal is to ensure the swaps market better serves the rest of the economy.
The law, in its simplest form, is about bringing competition and transparency to the swaps market. It’s about ensuring that businesses, whether small or large, and asset managers of any size have the access and information that swap dealers have enjoyed. It’s about lowering the risks of swap dealers and the swaps market to taxpayers.
As of October 12, these common-sense reforms are becoming a reality. Swap dealers are beginning the process of registration. We anticipate that many will do so by January 1. For the first time, regulators and the public are beginning to benefit from market transparency. And central clearing will soon lower risk and help level the playing field for anyone who wants to compete in the market.
I am also pleased that yesterday the Commission voted unanimously to put out for public comment a proposal on enhanced protections for customer funds. This proposal is about ensuring customers have confidence that the funds they post as margin or collateral are fully segregated and protected. I look forward to public input on the proposal.
Looking forward, we’re closing in on completing the swaps market reform rule set. I will now touch upon three principle areas in which the CFTC is working to finalize rules this year: the clearing requirement, transparency rules and the cross-border application of swaps market reform.
Clearinghouses have lowered risk for the public and fostered competition in the futures markets since the late 19th century.
Congress sought to bring similar benefits to our economy in requiring that standardized swaps between financial entities be centrally cleared.
Central clearing democratizes the market by eliminating the need for market participants to individually determine counterparty credit risk, as now the clearinghouse stands between buyers and sellers.
In a cleared market, more people have access on a level playing field.
Small and medium-sized businesses, banks and asset managers can enter the market and trade anonymously and benefit from the market’s greater competition.
CFTC rules completed earlier this year requiring that transactions be processed straight through to the clearinghouse were a necessary step toward achieving these goals. Compressing the time between trade execution and acceptance for clearing to, as our final rule says, “as quickly as would be technologically practicable if fully automated systems were used” enables any participant to transact on a level field. Such straight-through processing facilitates pre-trade transparency and the migration of the trading of swaps to swap execution facilities (SEFs) and designated contract markets.
In July, we embarked on the last step toward clearing of standardized swaps when we sought public input on which interest rate swaps and credit default swap (CDS) indices should be required to be cleared.
The initial set of clearing determinations may be finalized as early as next month, leading to required clearing by swap dealers and the largest hedge funds as early as February. Compliance would be phased in for other market participants through the summer of 2013. Market participants will be required only to clear swaps executed on and after their applicable compliance date, thus providing time to comply with the clearing requirement.
The transparency reforms of the 1930s have increased liquidity and competition in the securities and futures markets for decades. Such transparency – both pre- and post-trade -- levels the playing field by giving all market participants access to critical pricing and transaction information.
As of October 12, bright lights began to shine on the swaps market with reporting to swap data repositories of cleared interest rate and CDS transactions.
By the New Year, the public will benefit from real-time reporting for these transactions, as well as for uncleared swap transactions entered into by swap dealers.
Both real-time and regulatory reporting for energy and other physical commodity swaps as well as for broad-based equity index swaps begin shortly thereafter.
The public and regulators will have their first full window into the swaps marketplace. This transparency will lower costs for the rest of the economy and help financial markets better serve their function.
Further building upon on these post-trade transparency initiatives, we’ve consulted widely with market participants and with the SEC and international regulators regarding how best to finalize rules on minimum block sizes related to real-time reporting and SEFs. The CFTC is working to finalize these rules to provide the public with the enhanced liquidity and price competition that pre-trade transparency brings to markets.
Cross-border Application of Dodd-Frank Swaps Market Reform
Now I turn to that which might be most on your mind, the cross-border application of swaps market reform.
During a default or crisis, risk knows no geographic border. If a run starts on one part of a modern financial institution, almost regardless of where it is around the globe, it invariably means a funding and liquidity crisis rapidly spreads to the entire consolidated entity.
Then finance, rather than serving the rest of the economy, can threaten the rest of the economy.
This was true with the overseas affiliates and operations of AIG, Lehman Brothers, Citigroup and Bear Stearns.
AIG Financial Products’ swaps business was basically run out of Mayfair in London. It nearly brought down our economy.
A decade earlier, it was true, as well, with the collapse of the hedge fund Long-Term Capital Management. You may think of it as having been run out of Connecticut, but its swaps were booked in its Cayman Islands affiliate.
This year provided a reminder of this basic feature of modern finance when we heard the news of the CDS index products traded by JPMorgan Chase’s Chief Investment Office in London.
In enacting financial reform, Congress had these basic lessons in mind. Financial institutions’ hundreds of legal entities around the globe are still highly connected back to affiliates in this country.
When financial institutions or others operating outside the United States transmit risks directly into the U.S. through swap activities with U.S. persons, our laws provide for the regulation of such activities in the same manner as swap activities within the U.S.
Thus, the CFTC in June proposed guidance interpreting the cross-border application of the Dodd-Frank Act and an approach to phased compliance for foreign swap dealers.
The CFTC has been reviewing many thoughtful comments and consulting with the regulatory community here and abroad as we move to finalize them shortly. In the interim, the CFTC issued time-limited relief to certain foreign legal entities regarding the counting of swaps toward the de minimis swap-dealing threshold.
Implementation Guidance and Phasing
Given the new era of swaps market reform, it’s the natural order of things that market participants have sought further guidance. This regularly occurs as we move to market implementation from congressional legislation and agency rulemaking.
Fine-tuning is expected.
We welcome inquiries from market participants. My fellow commissioners and I, along with the CFTC staff, are all committed to sorting through issues as they arise, as we did for the issues brought to our attention leading up to October 12.
The CFTC also will continue to consult broadly on appropriately phasing in compliance. The Commission has included phased compliance schedules within many of our rules, including data, real-time reporting and the recent cross-border guidance. You can find extensive information on the compliance schedule for each of the reforms on our website.
Benchmark Interest Rates
Before I close, I’d like to turn to what may be one of the most critical challenges in the upcoming year. Benchmark interest rates, such as the London Interbank Offered Rate (LIBOR), are a key component of our financial markets, and they must work for the rest of the economy. To do so, they must be honest and reliable.
LIBOR is the reference rate for nearly half of U.S. adjustable-rate mortgages; for about 70 percent of the U.S. futures market; and for a majority of our swaps market.
For a benchmark rate for any commodity to be reliable and have integrity, it’s best to be anchored in real, observable transactions. It’s only through real transactions entered into at arm’s length between buyers and sellers that prices are discovered and set.
When market participants submit for a benchmark rate that lacks observable underlying transactions, even if operating in good faith, they may stray from what real transactions would reflect. Like walking in a dark forest, it’s easy to get lost, particularly over time.
When a benchmark is separated from real transactions, it is more vulnerable to misconduct.
The underlying market for interbank transactions in London, however, has largely diminished. Some say that it has basically disappeared.
This raises the challenge that many survey rates may no longer be based on sufficient numbers of interbank unsecured borrowing transactions to ensure that the relevant benchmarks are reliable.
As to some of these benchmarks, the UK Financial Services Authority recognized this point in its recent plan recommending reducing 150 benchmark rates to just 20, eliminating five of the currencies and 11 of the maturities for the remaining currencies.
As a next step, the market and market participants will need to focus on how to smoothly transition from benchmark rates that may have become obsolete. There have been circumstances in the past, albeit in smaller markets, such as the gasoline market, when a benchmark has become obsolete and a transition was put in place.
Several international organizations will be recommending approaches to next steps on benchmark interest rates, including the Bank for International Settlements and the International Organization of Securities Commissions (IOSCO). The IOSCO task force plans to seek public consultation hopefully starting in December. This will include a public roundtable and culminate in a report and recommendations in the spring. The IOSCO task force will be seeking public input on possible mechanisms and protocols that would best ensure for a smooth transition when needed.
I think it’s critical that we engage in a public discussion around these issues now.
I hope that these public discussions and efforts lead to benchmark rates that best serve the rest of the economy as honest and reliable reflections of the underlying markets to which they refer.
Bringing it back to basics again, the role of finance is to serve the rest of the economy. We all benefit when financial markets are open, transparent and competitive. The public, our economy and those in finance benefit.
The 1930s reforms that brought openness, transparency and competition -- and yes oversight -- to the securities and futures markets have been part of our nation’s great economic success.
Dodd-Frank was about bringing similar benefits to the public through swaps market reform. The CFTC has a bit of work left to do and will continue to benefit from broad public consultation and coordination with regulators here and abroad.
But with the passing of October 12, swaps market reforms are now becoming a reality.
Last Updated: October 23, 2012