November 6, 2013
Thank you, Walt, for that kind introduction. I also would like to thank the Futures Industry Association (FIA) for the invitation – I’m honored that you’ve invited me to speak each of these last five years.
Ever since Adam Smith and the Wealth of Nations, economists have consistently written that access to and transparency in markets benefits the broad public.
President Roosevelt understood this when he asked Congress during the Great Depression to bring transparency, access and competition to the commodities and securities markets.
The reforms of the 1930s transformed markets. They helped establish the foundation for the U.S. economic growth engine for decades.
Those reforms have given farmers, ranchers, producers, merchants and commercial companies confidence to use the futures market to manage their risks. They are able to lock in the price of a commodity at harvest time, or lock in an interest rate or currency rate, and focus on that which they do best – producing goods and services for the economy.
The swaps market emerged in the 1980s. It remained outside these time-tested reforms until last year.
Both futures and swaps, though, are just two forms of the same thing – derivatives. Both had become essential to our economy and to the way people and businesses manage risks.
The swaps market also had grown to dwarf the futures market in total notional outstanding. We now know the swaps market is $400 trillion in size, compared to the $30 trillion futures market.
Lacking of common-sense rules of the road, the swaps market contributed to the 2008 crisis. Need I remind anyone about AIG.
It became time to bring this vast, dark market into transparency. It became time to ensure that the broad public gained the benefits of central clearing and oversight of dealers.
Thus, the President and Congress passed reform borrowing from what had worked best for decades in the futures market.
Now, the swaps marketplace has been transformed.
It’s been a remarkable journey these past five years – and all of you have been part of this journey. It not only took 65 finalized rules, orders and guidances by the CFTC. Your thousands of comments, meetings and questions were a critical part of the process as well. You worked hard – with real costs and against deadlines – to implement these reforms to bring us to a new marketplace.
Foremost, the swaps marketplace now has transparency that simply did not exist in 2008.
The public now can see the price and volume of each swap transaction as it occurs. This post-trade transparency spans the entire market, regardless of product, counterparty, or whether it’s a standardized or customized transaction.
This information is available, free of charge, to everyone in the public. The data is listed in real time – like a modern-day tickertape – on the websites of each of the three swap data repositories.
Regulators get even greater transparency. Though there is more work to be done regarding the data flowing into data repositories, we now are able to see and filter the details on each of the 1.8 million transactions and positions in the data repositories.
Further, starting last month, the public – for the first time – has been benefitting from new transparency, access and competition on regulated swap trading platforms.
Economists have known the benefits of such transparency since the time of Adam Smith; it just wasn’t a reality in the swaps marketplace.
Now, as a result of reforms, swap execution facilities (SEFs) are required to provide all market participants with impartial access. They must provide dealers and non-dealers alike the ability to make and respond to bids, offers and requests for quotes. This is a basic tenant that Adam Smith and so many economists have laid out – that access and transparency promote competition and benefit the economy.
We now have 18 temporarily registered SEFs where more than a quarter of a trillion dollars in swaps trading is occurring on average per day. That is a big number by any measure.
We’ll continue to address questions as they arise to help smooth the transition to the transparency and impartial access of exchange trading.
Addressing one such question, as our cross border guidance directs, if a multilateral trading platform is a U.S. person, or it is located or operating in the U.S., it should register.
A multilateral trading platform that provides persons located in the U.S. with the ability to trade or execute swaps on the platform’s market (either directly or indirectly through an intermediary), should register.
Registration applies whether those persons are U.S. persons or non-U.S. persons whose personnel or agents are located in the U.S. This is regardless of the location where the swap is ultimately booked, including in circumstances where a swap dealer arranges, negotiates, or executes the terms of a swap in a non-U.S. branch, but trades swaps on a multilateral swaps trading platform using personnel or agents of the swap dealer located in the U.S.
This will trigger some SEF registrations for foreign-based platforms that are already registered with their home country. For instance, one Australian platform is going to register with the CFTC, and we’re working with the Australian home country regulators. We’re prepared to figure out where we might defer to those home country regulators.
Second, the swaps market has been transformed to a market with mandated central clearing for financial entities as well as dealers.
Customers now gain the benefit that until recently only dealers had. Central clearing of swaps lowers risk and allows customers more ready access to the market.
Clearinghouses have operated successfully at the center of the futures market for over 100 years – through two world wars, the Great Depression and the 2008 financial crisis.
Reforms have taken us from only 21 percent of the interest rate swaps market being cleared in 2008 to 80 percent during the week ending October 25, 2013.
That same week, we saw 62 percent of new credit index swaps being cleared.
Further, we no longer have the significant time delays that were once associated with swaps clearing.
Five years ago, swaps clearing happened either at the end of the day or even just once a week. This left a significant period of bilateral credit risk in the market, undermining one of the key benefits of central clearing.
Now reforms require pre-trade credit checks and straight-through processing for swaps trades intended for clearing.
As a result, 99 percent of swaps clearing occurs within 10 seconds, with 93 percent actually doing so within three seconds. No longer do market participants have to worry about credit risk when entering into swaps trades intended to be cleared.
Thus, breakage agreements – agreements that had been requested by dealers in the event a swap wasn’t accepted for clearing – are not needed and should not be required for access to trading on a SEF or designated contract market.
Taken as a whole, these reforms have completely transformed the swaps market to a new marketplace.
Third, the market has been transformed for swap dealers.
In 2008, swap dealers had no specific requirements with regard to their swap dealing activity.
Today, with 90 swap dealers registered, all of the world’s largest financial institutions in the global swaps market are coming under reforms.
These reforms include new business conduct standards for risk management, documentation of swap transactions, confirmations, sales practices, recordkeeping and reporting.
Just to note how significant this is – this past summer, swap dealers and their over 10,000 counterparties around the globe changed their swap documentation, lowering risk by cleaning up the back office.
These documentation reforms build on what the Federal Reserve Bank of New York had tried to achieve with dealers voluntarily.
I would note from my own experience in the financial community, those back office documents really matter in a bankruptcy or other crisis.
International Coordination on Swap Market Reform
Further, the transformed marketplace covers the far-flung operations of U.S. enterprises.
Congress was clear in the Dodd-Frank Act that we had to learn the lessons of the 2008 crisis.
AIG nearly brought down the U.S. economy through its guaranteed affiliate operating under a French bank license in London.
Lehman Brothers had 3,300 legal entities when it failed. Its main overseas affiliate was guaranteed here in the U.S., and it had 130,000 outstanding swap transactions.
A decade earlier, Long-Term Capital Management was operating out of Connecticut but actually booked their $1.2 trillion derivatives book in the Cayman Islands.
Based upon CFTC guidance, 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.
As of last month, offshore branches and guaranteed affiliates, as well as hedge funds, like Long-Term Capital Management, all had to come into central clearing and the other Dodd-Frank reforms.
Market events of the last two years also highlighted the need to further ensure the protection of customer funds.
Segregation of customer funds is the core foundation of the commodity futures and swaps markets.
Segregation must be maintained at all times. That means every moment of every day.
The CFTC went through a two-year process with market participants, including significant input from the FIA, to ensure that customers have confidence that their funds are segregated and protected. Last week, the sixth set of customer protection rules were finalized by the Commission.
Before I take questions, I wanted to share a few thoughts looking forward.
First there will be the continued implementation of reforms. Among the highlights is the trade execution mandate likely going live in the first quarter of 2014. Also, there is the critical implementation of the recently completed customer protection rules. The CFTC will continue pivoting from rulewriting to ensuring compliance with these reforms.
Second, it is critical that we preserve the pre-trade transparency that has been a longstanding hallmark of the futures market. The Commission finalized a block rules for swaps and soon will consider staff recommendations for a proposal on a futures block rule.
Third, we have witnessed a fundamental shift in markets from human-based trading to highly automated trading. The Commission looks forward to hearing back on our concept release on automated and high frequency trading.
Fourth, we must deal with the fact that LIBOR is more akin to fiction than fact. Through five settlements the CFTC has brought against banks, we have seen how the public trust can be violated through bad actors readily manipulating benchmark interest rates. As LIBOR and Euribor are not anchored in observable transactions, they have been and can be again readily and pervasively rigged.
The work of the Financial Stability Board to find alternatives and consider potential transitions to these alternatives is critical. This will mean significant changes in the futures and swaps markets. There is a need for these reforms, though, if we’re going to protect the integrity of the markets.
Lastly, one of the greatest threats to well-functioning, open, and competitive futures and swaps markets is that the CFTC – the agency tasked with overseeing your markets – is not sized to the task at hand.
That the CFTC completed 65 rulemakings should not be confused with the agency having sufficient people and technology to oversee the markets.
At 673 people, we are only slightly larger than we were 20 years ago. Since then though, the futures market has grown and changed significantly. Further, we have this new job of overseeing the vast swaps market.
The overall branding of these markets is dependent on customers having confidence in using them.
It’s also critical that we have the resources for the timely reviews of applications, registrations, petitions and answers to market participants’ questions.
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 was forced to notify employees of an administrative furlough for up to 14 days this fiscal year.
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 for transparent, well-functioning markets.
Let me close by thanking all of you. These last five years have been a remarkable journey. The futures market performed well straight through the crisis. That’s why we borrowed so much from the futures market in an effort to bring much-needed reform to the swaps market.
On a personal note, I want to thank you for all that we’ve achieved together. I want to thank you because this may be my last speech as the CFTC’s Chairman at an FIA conference. I assure you, though, if invited, I’ll be with you again.
Thank you, I look forward to answering your questions.
Last Updated: December 30, 2013