September 19, 2013
Thank you, Bob, for that introduction. I would also like to thank the International Swaps and Derivatives Association (ISDA) for the invitation to speak at this annual European conference.
Five years ago this week, the U.S. economy was in a free fall. Federal Reserve Chairman Bernanke and then Treasury Secretary Paulson faced the unthinkable – asking the American people to bail out financial institutions to save the economy.
Five years ago, the swaps market was at the center of the crisis. It cost middle-class Americans – and hardworking people across the globe – their jobs, their pensions and their homes.
Five years ago, there was no reporting of swaps to the public or to regulators
Five years ago, the swaps market was largely uncleared.
Five years ago, unregulated dealers dominated the market.
Five years ago, swaps were not exchange traded – all classic attributes of a dark market.
President Obama then met in 2009 with the G-20 leaders in Pittsburgh. They committed to bringing the swaps market into the light through transparency and oversight.
The President, working with the U.S. Congress, in 2010 gave the task of implementing swaps market reform to the Commodity Futures Trading Commission (CFTC) and security-based swaps market reform to the Securities and Exchange Commission.
Today, the CFTC has substantially completed these reforms.
The CFTC’s 61 final rules, orders and guidance have brought traffic lights, stop signs, and speed limits to the once dark and unregulated swaps roads.
This new era of swaps market reform began to be implemented last October 12. With numerous implementation dates behind us and a number of critical dates coming up, the transition to a reformed swaps market is fully in motion.
This represents a paradigm shift to a transparent, regulated marketplace.
Today, the public can see the price and volume of each swap transaction as it occurs on a website, like a modern-day tickertape. Further, half of the swaps market (by volume) is being reported to the public without delay – or as Congress mandated “as soon as technologically practicable.” Soon swaps will be traded on transparent platforms.
This transparency lowers costs for investors, consumers and businesses. It increases liquidity, efficiency and competition.
Regulators have benefited as well. Nearly $400 trillion in market facing swaps now are being reported into data repositories. There is still work to be done to ensure the data in the warehouses is reliable and accessible. There is still work to be done to aggregate across data warehouses as well. But this market transparency is a reality.
This transparency also spans the entire marketplace – cleared as well as bilateral or customized swaps. All categories of market participant from swap dealers to end-users now are to report transactions. Every product, without exception, now must be reported – interest rate; cross currency; foreign exchange; credit index; equity index; and commodities, such as energy and agricultural.
On September 30, the far-flung operations of U.S. financial entities, the guaranteed affiliates and the branches of U.S. persons, also will begin required public reporting.
Further, starting October 2 the public will benefit from the competition and transparency that swap execution facilities (SEFs) will bring to the marketplace. All market participants will have impartial access to SEFs where they can leave live, executable bids or offers in an order book.
We have 18 SEF applications, with seven of them now temporarily registered.
These reforms will finally close what had been known in the U.S. as the “Enron Loophole,” which had allowed for unregistered, multilateral swaps trading platforms.
Five years ago, this market transparency was nonexistent.
This month, with the completion of phased implementation, mandatory clearing of interest rate and credit index swaps is a reality. Clearinghouses lower risk and promote access for market participants.
In the month of August, even before our last domestic clearing compliance date, 63 percent of new interest rate swaps were cleared. In total, nearly $180 trillion of the approximately $330 trillion market facing interest rate swaps market, or 53 percent, was cleared at the end of August. This compares to only 21 percent of the market in 2008, according to information on ISDA’s website.
On October 9, the guaranteed affiliates and branches of U.S. persons also will come into central clearing. This includes hedge funds that are operating in the United States but are incorporated in the Cayman Islands.
As we move into 2014, I would anticipate that closer to two-thirds of the interest rate swaps market will be in central clearing.
Yet five years ago, there was no required clearing in the swaps market.
We’ve also made significant progress since the crisis on reforms to protect both futures and swaps customers through the CFTC’s gross margining and the so-called “LSOC” (legal segregation with operational comingling) rules.
Commissioners now are considering final rules that would further strengthen controls around customer funds.
Swap Dealer Oversight
In 2008, swaps were basically not regulated in the United States, Europe or Asia. Among the reasons for this, it was claimed that financial institutions did not need to be specifically regulated for their swaps activity, as they or their affiliates already were generally regulated as banks, investment banks, or insurance companies.
AIG’s downfall was a clear example of what happens with such limited oversight.
Today, we have 82 swap dealers and two major swap participants registered. This group includes the world’s 16 largest financial institutions in the global swaps market, commonly referred to as the G16 dealers. It also includes a number of energy swap dealers.
These reforms help protect the public, lower risk and increase market integrity as swap dealers now must report their transactions and comply with sales practice and other business conduct standards.
Working closely with our counterparts in Europe, we have essentially identical risk mitigation rules that include promoting the timely confirmation of trades and documentation of the trading relationship. Through ISDA protocols, 9,100 market participants have amended their documents to conform to the new U.S. risk mitigation requirements, and 5,200 market participants have conformed to European standards. More than 10,900 market participants are adhering to ISDA’s protocols for sales practices.
These reforms will significantly lower the risk of the swaps market to the public and the economy.
Five years ago, such oversight of swap dealers did not exist.
International Coordination on Swap Market Reform
AIG nearly brought down the U.S. economy through the operations of its offshore guaranteed affiliate.
It wasn’t the only U.S. financial institution that brought risk back home from its far-flung operations during the 2008 crisis.
It was also true at Lehman Brothers, Citigroup, and Bear Stearns. Ten years earlier, it was true at Long-Term Capital Management.
The nature of modern finance is that financial institutions commonly set up hundreds, or even thousands, of legal entities around the globe. When a run starts on any part of an overseas affiliate or branch of a modern financial institution, risk crosses international borders.
The U.S. Congress was clear in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) that the far-flung operations of U.S. enterprises are to be covered by reform.
The CFTC, coordinating closely with global regulators, completed guidance on the cross-border application of the Dodd-Frank Act in July. Swaps market reform covers transactions between non-U.S. swap dealers and guaranteed affiliates of U.S. persons, as well as swaps between two guaranteed affiliates.
Further, the guidance captures offshore hedge funds and collective investment vehicles that have their principal place of business in the U.S. or that are majority owned by U.S. persons.
The guidance embraces the concept of substituted compliances where there are comparable and comprehensive rules abroad. We are currently reviewing submissions for entity-level substituted compliance in six jurisdictions (the European Union, Australia, Canada, Hong Kong, Japan and Switzerland). We’re consulting closely with regulators in those jurisdictions and look forward to making determinations prior to December 21 of this year.
Benchmark Interest Rates
Five years ago, interest rate benchmarks such as LIBOR and Euribor were being readily and pervasively rigged.
Working with the Financial Conduct Authority and the U.S. Justice Department, we brought actions against three global banks for such abuses.
LIBOR and Euribor are critical reference rates for global futures and swaps markets. In the U.S., LIBOR is the reference rate for 70 percent of the futures market and more than half of the swaps market. It is the reference rate for more than $10 trillion in loans.
We must ensure that these benchmark interest rates have market integrity and that they are based on fact, not fiction.
The interbank, unsecured market that the benchmarks are intended to measure, however, essentially no longer exists, particularly for longer tenors.
The U.S. Financial Stability Oversight Council recommended that U.S. regulators work with foreign regulators, international bodies, and market participants to promptly identify alternative interest rate benchmarks anchored in observable transactions and supported by appropriate governance structures, and to develop a plan to accomplish a transition.
An International Organization of Securities Commissions (IOSCO) task force took an important step in announcing new principles in July that require benchmarks to be anchored by observable transactions and subject to robust governance processes that address potential conflicts of interest.
Building on IOSCO’s work, the Financial Stability Board is initiating a review of alternatives to existing benchmark interest rates, as well as considering any potential transition issues.
I want to thank Martin Wheatley, with whom I’ve worked so closely on these issues, for all of his efforts and leadership.
In the five years since the financial crisis, the swaps market has experienced a paradigm shift.
No longer is the market closed and dark.
With the substantially completed reforms, the public and regulators have transparency. We have a majority of the market moving to central clearing. We have oversight of swap dealers, including the far-flung operations of U.S financial institutions.
The public and the markets are benefitting from these common-sense rules of the road.
I’d like to close by saying that the CFTC is currently an underfunded agency. We are only slightly larger than we were 20 years ago. At that time, we oversaw just the futures market, which is less than a tenth of the size of the swaps market we now oversee as well.
It is critical to the public’s confidence in these markets that the regulator is well funded.
Investments in both people and technology are needed for effective market oversight – like having more cops on the beat.
It’s only with a well-funded CFTC that market participants, including this association’s members, will get timely reviews of applications and petitions and answers to your questions.
Last Updated: September 19, 2013