November 1, 2012
Note: the Chairman’s remarks are being delivered via video this morning at the FIA Expo, as he was unable to travel to Chicago due to Hurricane Sandy.
Good morning, I want to thank the Futures Industry Association (FIA) for inviting me to speak at your Expo 2012 in Chicago. I’m only sorry that Hurricane Sandy prevented me from being there for my scheduled speech yesterday. It would have been my fourth year at the Expo. I’m glad that you could arrange for me to speak to you from a distance.
Millions of Americans were affected by Sandy’s devastation this week, and we are all thinking of these families as they work to recover.
This week’s natural disaster also tested the resilience of everyone working in the markets.
I want to compliment all of the dedicated participants in the futures and swaps markets for the efforts in keeping markets functioning these last few days. All clearing and settlement functions worked smoothly. This is a testament to clearing members, clearinghouses, exchanges and the broad market.
Through your planning, farmers, ranchers, producers, commercial companies and financial institutions could continue to manage and hedge their risks.
This week’s weather disaster makes me think of an earlier disaster, albeit manmade, the 2008 financial disaster.
As we rebuild from this natural disaster, we’ll be examining ways to better protect the public from and be prepared for the next storm.
After 2008, we had to rebuild from a financial disaster. Similarly, we had to examine ways to better protect the public.
In so doing, it was appropriate to take things back to basics.
The role of finance and financial markets is to allocate and price both investments and risk throughout our economy.
It is to allow the public unfettered access to markets and information, and establish prices transparently and free of fraud and manipulation.
In sum, it’s about ensuring that finance serves the rest of the economy.
Though the markets and related regulation evolve over time, these goals have been met in the futures world for decades.
But as the financial system failed in 2008, the swaps market, which was basically not regulated, failed to meet these objectives.
The swaps marketplace operated without the basic transparency and common-sense reforms that Americans have benefitted from since the 1930s.
Those historic reforms established a foundation of transparency, competition and market integrity for the futures and securities markets. This democratization of our financial markets has led to many decades of economic growth and innovation.
The 2008 financial disaster caused great damage. Eight million American jobs were lost. Just like Hurricane Sandy, it affected millions of bystanders far and wide.
In response, Congress and the President borrowed from what has worked best in the futures markets in passing the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
Your meeting in Chicago is at a time of great change.
As of October 12, the new era of swaps market reform began. This will lead to significant benefits for the public. It also presents opportunities as well as challenges for market participants.
Futures markets participants have been rising to the occasion.
I’d like to briefly review with you three key initiatives that commissioners will consider and hopefully finalize by the end of this year: the clearing requirement, transparency reforms and the cross-border application of Dodd-Frank. Two other important items that we’re seeking additional public input on are enhancing customer protection and ensuring for the integrity of benchmark interest rates.
As we work through these initiatives, I believe it’s also critical that we continue our efforts to put in place aggregate position limits across futures and swaps, as Congress directed the CFTC to do.
The Clearing Requirement
Clearinghouses have lowered risk for the public and fostered competition in the futures markets since the late 19th century.
Central clearing equalizes access to the market and democratizes it by eliminating the need for market participants to individually determine counterparty credit risk.
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 swaps trading to swap execution facilities (SEFs) and designated contract markets (DCMs).
In July, we embarked on the last step toward clearing of standardized swaps when we sought public input on the first set of swaps that will be required to be cleared.
The initial set of clearing determinations for interest rate swaps and credit default swaps 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 February. Compliance would be phased in for other market participants through the summer of 2013.
The transparency reforms of the 1930s have increased liquidity and competition in the 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 when cleared interest rate and CDS transactions began to be reported to swap data repositories.
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.
This post-trade transparency will lower costs for the rest of the economy and help financial markets better serve their function.
Staff recommendations on final rules for SEFs and minimum block size are now with my fellow commissioners for their consideration.
These rules will bring pre-trade transparency to the swaps market, which means enhanced liquidity and price competition. By moving the trading of swaps to SEFs or DCMs, market participants can view the prices of available bids and offers. The pre-trade transparency of SEFs and DCMs will build on the democratization of the swaps market that comes with the clearing of standardized swaps.
Cross-border application of swaps market reform
Comprehensive oversight of swap dealers will promote transparency and lower their risk to the rest of the economy.
With swap market reform now a reality, we anticipate many dealers will register by January 1.
In enacting financial reform, Congress had the basic lessons of modern finance and the 2008 crisis in mind. Congress knew that when 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 AIG, whose affiliate AIG Financial Products’ swaps business was basically run out of Mayfair in London. It nearly brought down the U.S. economy.
To give financial institutions and market participants guidance on the cross-border application of Dodd-Frank, the CFTC in June sought public input on an interpretation of these provisions.
In consultation with the international regulatory community, the CFTC will move shortly to finalize the cross-border and phased-compliance releases.
Segregation of customer funds is the core foundation of customer protection in the commodity futures and swaps markets.
Last week, the Commission put out for public comment a proposal on enhanced protections for customer funds. The commission looks forward to public input on these reforms.
This proposal is about ensuring customers have confidence that the funds they post as margin or collateral are fully segregated and protected.
It is the direct result of significant input from the public and market participants that the CFTC gathered throughout the year, working with the FIA, the National Futures Association and the self-regulatory organizations (SROs).
It would strengthen the controls around customer funds at futures commission merchants (FCMs). It also would set new regulatory accounting requirements that would provide stronger protections for customer money held by FCMs and would raise minimum standards for independent public accountants who audit FCMs. And it would provide regulators with daily direct electronic access to FCMs’ bank and custodial accounts for customer funds.
These rules would build upon the completed amendments to rule 1.25 regarding the investment of customer funds, which prevented the use of in-house lending through repurchase agreements.
In addition, the so-called “LSOC rule” (legal segregation with operational comingling) for swaps will be implemented this month. In light of Hurricane Sandy, CFTC staff will provide market participants a little more time, moving the compliance date from November 8 to November 13.
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.
There are four broad questions that market participants and international regulators are focusing on with regard to benchmark rates.
First, what are the best practices to ensure for a reliable benchmark?
I believe for a benchmark rate for any commodity or swap 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 we can be confident that prices are discovered and set accurately.
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. 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.
Second, in light of these best practices, how do the current survey benchmark rates measure up in comparison? Among other important questions, do they have sufficient numbers of underlying transactions to ensure their reliability and honesty?
The UK Financial Services Authority (FSA) addressed this point, in part, 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.
Third, what alternatives might there be for interest rate benchmarks? Possibilities include the overnight index swaps rate or benchmark rates based on actual short-term financings between banks and other financial institutions.
Lastly, how do we ensure for a smooth transition from benchmark rates that may have become obsolete or if markets move to an alternative rate?
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. The International Organization of Securities Commissions task force will be seeking public input on possible mechanisms and protocols that would best ensure for a smooth transition when needed.
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.
The futures market has done so for decades by providing price discovery and liquidity through transparent and competitive markets.
The manmade financial disaster of 2008 highlighted the need to bring similar reform to the swaps market.
The CFTC has a bit of work left to do, but with the passing of October 12, swaps market reforms are now becoming a reality.
Thank you again for inviting me, and I’m just sorry that I wasn’t able to be there in person.
I’d also like to thank and recognize each of my fellow Commissioners: Jill Sommers, Bart Chilton, Scott O’Malia and Mark Wetjen for their dedication and significant contributions – as well as all of the CFTC staff.
Again, my thoughts go out to all of those families working to rebuild after the devastation of Hurricane Sandy.
Last Updated: November 1, 2012