October 31, 2013
Thank you, Art, for that kind introduction. I also would like to thank George Washington University for the invitation to speak today.
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.
Five years ago, middle-class Americans lost their jobs, their pensions and their homes in the worst crisis since the Great Depression.
Five years ago, the swaps market contributed to the financial system failing the real economy. Thousands of businesses closed their doors.
President Obama gathered the G-20 leaders in Pittsburgh in 2009. 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.
Congress essentially mandated a complete overhaul of the derivatives market – to a New Marketplace.
Now, through the CFTC’s 65 final rules, orders and guidances this New Marketplace is a reality – benefitting investors, consumers and businesses.
Today’s New Marketplace means there are bright lights of transparency shining though this $400 trillion market.
Today’s New Marketplace means there are robust safety measures in place that didn’t exist in 2008.
These reforms are based on time-tested ideas.
Since Adam Smith and the Wealth of Nations, economists have consistently written about how the broad public benefits from the access and competition transparency brings to a market.
As we have since Adam Smith’s days, we prosper from our market-based economy.
But it is only through a standard set of common-sense rules of the road that we lower uncertainty, level the playing field and protect against abuses.
Significant new transparency is the foremost change in this New Marketplace.
There has been a real paradigm shift.
Since early this year, the public can see the price and volume of each swap transaction as it occurs. This is across the entire market, regardless of product, counterparty, or whether it’s a standardized or customized transaction.
This information is free of charge and available on the Internet, like a modern-day tickertape.
Also beginning earlier this year, regulators are able to see the details on each of the transactions and positions that are in this $400 trillion swaps marketplace. We’re able to see those details for each of the 1.8 million transactions in the data repositories. We can filter this information and see what individual financial institutions are doing in the marketplace.
This new window into the market is an enormous change since 2008.
Further, starting this month, the public – for the first time – is benefitting from new transparency, access and competition on swap trading platforms.
Once fully phased in, market participants will benefit from seeing competitive prices before they enter into a transaction.
This is because swap execution facilities (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.
Requiring trading platforms to be registered and overseen by regulators was central to the New Marketplace reforms President Obama and Congress included in the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). They expressly repealed exemptions, such as the so-called “Enron Loophole,” for unregistered, multilateral swap trading platforms.
Seventeen SEFs are temporarily registered. This again 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.
The second fundamental change of this New Marketplace is central clearing.
Clearinghouses stand between buyers and sellers of derivative contracts, protecting them in case one of them goes bankrupt. Clearinghouses lower risk and promote access for market participants. They have worked since the 1890s in the futures market but were not widely used in the swaps marketplace – until now.
Last week, 80 percent of new interest rate swaps were brought into central clearing. That compares to only 21 percent in 2008. Going from a 21 percent market share to an 80 percent market share in any business would deserve some attention.
Given that clearing was still being phased in over the course of this year, in total over $190 trillion of the approximately $340 trillion market facing interest rate swaps market, or 57 percent, was cleared as of last week.
Swap Dealer Oversight
The third fundamental change of this New Marketplace is that swap dealers are now being regulated for their swaps activity.
Prior to these reforms – though one needs a license to be a stockbroker – the largest, most sophisticated financial dealers in the world weren’t required to have any special license for their swaps dealing activity. AIG’s downfall was a clear example of what happens with no registration or licensing requirement for such dealers.
Congress understood this and mandated that swap dealer registration was a critical part of this New Marketplace. Today, we have 88 swap dealers 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.
All of these registered dealers now have to comply with new business conduct standards for risk management, sales practices, recordkeeping and reporting.
International Coordination on Swap Market Reform
In the New Marketplace, the far-flung operations of U.S. enterprises are covered under reform.
Congress was clear in the Dodd-Frank Act that we had to learn the lessons of the 2008 crisis. Money and risk knows no geographic border.
AIG nearly brought down the U.S. economy because it guaranteed the losses of a Mayfair branch operating under a French bank license in London.
Lehman Brothers had 3,300 legal entities, including a London affiliate that was guaranteed here in the United States, and it had 130,000 outstanding swap transactions.
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. Any one of the legal entities can take down the entire company.
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.
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.
Benchmark Interest Rates
The CFTC has changed the way the world thinks about benchmark interest rates.
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, through five settlements against banks, we have seen how the public trust can be violated through bad actors readily manipulating 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 this week and our four prior cases.
These five instances of benchmark manipulative conduct highlight 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.
The CFTC is basically done with rulewriting, the first significant compliance dates have passed and the New Marketplace is here. 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.
One of the greatest threats to well-functioning, open, and competitive swaps and futures markets is that the agency tasked with overseeing them is not sized to the task at hand.
At 674 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 size of the futures market we oversaw just four years ago. Further, the futures market itself has grown fivefold since the 1990s.
We need people to examine the clearinghouses, trading platforms, clearing members 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 to 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 again for inviting me to speak today; I’m pleased to say it’s my fifth time speaking at GW. In the past, I’ve spoken about the need for swaps market reform. Today, I’m glad to tell you that the New Marketplace is a reality.
This marketplace also has significant new protections for customer funds, as well as significantly more transparency for asset managers, known as commodity pool operators.
I’ll close with this: swaps market reform also is a key component in ensuring that when the next financial firm fails, that the financial system is not too interconnected, too complex or too in the shadows to prevent the firm from having the freedom to fail.
After World War II, my dad took his $300 mustering-out pay and started what became the family business. He knew that if he didn’t make payroll, nobody was going to bail him out.
If he were alive, he would say it shouldn’t be any different for banks and other large financial institutions. That’s what Congress said, as well, in passing Dodd-Frank financial reform. Companies, large and small, should be free to innovate, to grow, and, yes, to fail without taxpayer support.
Thank you, and I look forward to answering your questions.
Last Updated: October 31, 2013