October 29, 2013
Thank you, Bob, for that kind introduction. I also would like to thank you and Harvard University for the invitation to speak today. I’m particularly pleased to be here as Bob and I are both examples that there is life after serving as an undersecretary of the Treasury.
Five years ago, the U.S. economy was in a free fall.
Five years ago, the swaps market was at the center of the crisis. It cost middle-class Americans – and hardworking people around the globe – their jobs, their pensions and their homes.
Five years ago, the swaps market contributed to the financial system failing corporate America and the economy as a whole. Thousands of businesses closed their doors.
President Obama 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 and 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.
With the CFTC’s near completion of these reforms, the shift to a transparent, regulated marketplace benefitting investors, consumers and businesses is fully in motion.
The CFTC’s 62 final rules, orders and guidance have brought traffic lights, stop signs, and speed limits to the once dark and unregulated swaps roads.
There are bright lights and robust safety measures in place that didn’t exist in 2008.
With these reforms, farmers, ranchers, producers and commercial companies can continue to rely on transparent, competitive markets to lock in a price or a rate and focus on what they do best – innovating, producing goods and services for the economy, and creating jobs.
These reforms are not based on new ideas. Economists have written about them for centuries. Just start with Adam Smith in the Wealth of Nations where he wrote about the benefits of lowering the price of information and the price of access. In essence, if you make information free, the economy benefits. Similarly, if access to the market is free, everybody gets to compete.
Thus, in line with Adam Smith, the first critical component of swaps market reform is transparency.
Today, the public can see the price and volume of each swap transaction as it occurs on a website, like a modern-day tickertape.
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 are being reported into data repositories.
This transparency spans the entire marketplace – cleared as well as bilateral or customized swaps. Every product, without exception, now must be reported.
Further, starting this month, the public is benefitting as swap trading platforms come under new common-sense rules of the road.
Over time, market participants will benefit from the enhanced pre-trade transparency and competition of these new trading platforms, called swap execution facilities (SEFs).
SEFs are required to provide all market participants – dealers and non-dealers alike – with impartial access, once again following Adam Smith’s observations on how to benefit the economy.
Further, SEFS provide the ability to compete by leaving live, executable bids or offers in an order book.
Requiring trading platforms to be registered and overseen by regulators was central to the swaps market reform President Obama and Congress included in the Dodd-Frank Wall Street Reform and Consumer Protection Act. They expressly repealed exemptions, such as the so-called “Enron Loophole,” for unregistered, multilateral swap trading platforms.
Seventeen SEFs are temporarily registered. This is truly a paradigm shift – a transition from a dark to a lit market. It’s a transition from a mostly dealer-dominated market to one where others have a greater chance to compete.
Another key component of completed swaps reforms is bringing transactions among financial institutions into central clearing.
This month, mandatory clearing of interest rate and credit index swaps is a reality for swap dealers, hedge funds and other financial institutions.
Clearinghouses lower risk and promote access for market participants.
As of October 25, 80 percent of new interest rate swaps were cleared. In total, over $190 trillion of the approximately $340 trillion market facing interest rate swaps market, or 57 percent, was cleared. This compares to only 21 percent of the market in 2008.
Earlier this month, the guaranteed affiliates and branches of U.S. persons were required to come into central clearing. Further, hedge funds and other funds whose principal place of business is in the United States or that are majority owned by U.S. persons are required to clear as well. No longer will a hedge fund with a P.O. Box in the Cayman Islands for its legal address be able to skirt the important reforms Congress put in place.
Swap Dealer Oversight
The third key component of swaps market reform is bringing oversight to swap dealers.
In 2008, swaps activity was 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 88 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.
Swap dealer oversight helps protect the public. It lowers risk and increases market integrity. Swap dealers throughout this year have had to report their transactions and comply with sales practice and other business conduct standards.
International Coordination on Swap Market Reform
Since the 2009 meeting in Pittsburgh, the CFTC has been consistently coordinating with our international counterparts on swaps market reform. The United States, Europe, Japan and the largest provinces in Canada all have made substantial progress.
As the CFTC and the international regulatory community move forward with reform, we all recognize that risk knows no geographic border. 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.
The guidance embraces the concept of substituted compliances, or relying on another country’s rules when they are comparable and comprehensive.
This guidance is critical to protecting the public from the risk of foreign-affiliate failures in the future.
Benchmark Interest Rates
Today, the CFTC announced its fifth settlement against a bank for pervasively rigging key interest rate benchmarks, LIBOR and Euribor.
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.
Unfortunately, we once again see how the public trust can be violated through bad actors readily manipulating benchmark interest rates.
Through hundreds of manipulative acts spanning six years, in six offices, and on three continents, more than two dozen Rabobank employees, including a senior manager, manipulated, attempted to manipulate and falsely reported crucial reference rates in global financial markets. Rabobank employees also aided and abetted other banks to manipulate benchmark interest rates.
I wish I could say that this won’t happen again, but I can’t.
LIBOR and Euribor are not sufficiently anchored in observable transactions. Thus, they are basically more akin to fiction than fact. That’s the fundamental challenge so sharply revealed by Rabobank and our prior cases.
This fifth instance of benchmark manipulative conduct highlights the critical need to find replacements for LIBOR and Euribor – replacements truly anchored in observable transactions.
Though addressing governance and conflicts of interest regarding benchmarks is critical, that will not solve the lack of transactions in the market underlying these benchmarks.
That is why the work of the Financial Stability Board to find alternatives and consider potential transitions to these alternatives is so important. The CFTC looks forward to continuing to work with the international community on much-needed reforms.
I’d like to close on one of the greatest challenges to well-functioning swaps and futures markets. That challenge is that the agency tasked with overseeing these markets is not sized to the task at hand.
At 675 people, we are only slightly larger than we were 20 years ago. Since then though, Congress gave us the job of overseeing the $400 trillion swaps market, which is more than 10 times the market we oversaw just four years ago. Further, the futures market itself has grown fivefold since the 1990s.
You might not have liked the umpire’s call in the game this week on obstruction, but would you want Major League Baseball to expand tenfold and not add to its corps of umpires?
We’ve basically completed the task of writing all the reforms and are past the initial market implementation dates. We’ve brought the largest and most significant enforcement cases in the Commission’s history.
These successes, however, should not be confused with the agency having sufficient people and technology to oversee these markets.
We need people to examine the clearinghouses, trading platforms and dealers. We need surveillance staff to actually swim in the new data pouring into the data repositories. We need lawyers and analysts to answer the many hundreds of questions that are coming in from market participants about implementation. We need sufficient funding to ensure this agency can closely monitor for the protection of customer funds. And we need more enforcement staff to ensure this vast market actually comes into compliance and go after bad actors in the futures and swaps markets.
The President has asked for $315 million for the CFTC. This year we’ve been operating with only $195 million.
Worse yet, as a result of continued funding challenges, sequestration and a required minimum level Congress set for the CFTC’s outside technology spending, the CFTC already has shrunk 5 percent, and just last week, was forced to notify employees that they would be put on administrative furlough for up to 14 days this year.
I recognize that Congress and the President have real challenges with regard to our federal budget. I believe, though, that the CFTC is a good investment for the American public. It’s a good investment to ensure the country has transparent and well-functioning markets.
Thank you, and I look forward to your questions.
Last Updated: October 29, 2013