Thank you, Terry, for that kind introduction. I also would like to thank the CME Group for the invitation.
Since the time of Adam Smith and The Wealth of Nations, economists have consistently written that transparency and open access to markets benefits the broad public and the overall economy.
When markets are open and transparent, markets are more efficient, competitive, and liquid, and costs are lowered for companies and their customers.
President Roosevelt understood this when he asked Congress during the Great Depression to bring transparency, access and competition to the futures 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.
The swaps market emerged nearly 50 years later, but remained dark and closed until just last year.
The swaps market had grown to dwarf the futures market in total notional outstanding. We now know the swaps market is $380 trillion in size, compared to the $30 trillion futures market.
Lacking common-sense rules of the road, the swaps market contributed to the 2008 crisis.
Thus, President Obama and Congress passed reform borrowing from what had worked best in the futures market.
With the completion of nearly all of the agency’s rules and the initial major compliance dates behind us, the marketplace has been transformed.
Bright lights now are shining on the swaps market. Transparency is shining both prior to and after a trade.
The playing field has been leveled through transparency, impartial access, central clearing and straight-through processing. Asset managers, pension funds, insurance companies, community banks and all market participants are gaining benefits that until recently, only swap dealers had.
It’s been a remarkable journey these past five years – and all of you have been part of it. It not only took the CFTC’s 67 finalized rules, orders and guidances. Your thousands of comments, meetings and questions were a critical part of the process. 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.
The public can see the price and volume of each swap transaction as it occurs.
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 the three swap data repositories.
Regulators also have gained transparency into the details on each of the 1.8 million transactions and positions in data repositories.
Starting last month, the public – for the first time – has been benefitting from new transparency, impartial access and competition on regulated swap trading platforms.
SEFs are required to provide dealers and non-dealers alike the ability to view, place, or respond to all indicative or firm bids and offers, as well as to place, receive, and respond to requests for quotes.
This pre-trade transparency lowers costs for investors, businesses and consumers, as it shifts information from dealers to the broader public.
Congress required that certain standardized swaps must be executed on a SEF or designated contract market (DCM). The trade execution requirement covers all swaps that are subject to mandatory clearing and made available to trade.
We now have 19 temporarily registered SEFs where more than a quarter of a trillion dollars in swaps trading is occurring on average per day.
Four SEFs have made filings for a wide range of interest rate and credit index swaps to be determined made available for trading.
With 90 registered swap dealers, including the world’s largest liquidity providers in interest rate and credit index swaps, sufficient liquidity exists across the entire interest rate swap curve to support these filings.
Thus, I anticipate that by next February, there will be a trade execution requirement for a significant portion of the interest rate and credit index swap markets.
Second, the swaps market has been transformed to a market with mandated central clearing for financial entities as well as dealers.
Central clearing 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 crisis.
Reforms have taken us from only 21 percent of the interest rate swaps market being cleared in 2008 to approximately 70 percent of the market this fall. More than 60 percent of new credit index swaps are 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 a key benefit 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 swap trades intended to be cleared.
Thus, breakage agreements – agreements that dealers had requested 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 DCM.
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.
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 2008.
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.
We also have been asked by a number of foreign-based swaps dealers if Dodd-Frank applies to them when they are arranging, executing or negotiating swaps in the United States. We thought the answer was pretty clear, but we put out an advisory reminding people that the answer is yes.
A U.S. swap dealer on one floor of a New York building and a foreign-based swap dealer along the same elevator bank are required to follow the same rules when arranging, negotiating or executing a swap.
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 every moment of every day.
The CFTC went through a two-year process with market participants, including the CME, to ensure that customers have confidence that their funds are segregated and protected. Last month, the Commission finalized the sixth set of customer protection rules.
Before I take questions, I wanted to share a few thoughts looking forward.
First, the CFTC largely has moved beyond rule writing and initial compliance dates. We have moved on to reviewing registered entities and registrants to ensure they fully come into compliance.
As we have done for many years, we are doing this through examinations, surveillance, enforcement and issuing guidance and advisories. To smooth implementation, we will continue to work with market participants as needed.
We know the markets are undertaking a significant effort to ensure a smooth transition, including steps to incorporate guidance and advisories. We will continue working with market participants, but when there is a question, the best thing to do is to come into compliance with all of the CFTC’s rules and guidance.
Second, the CFTC really does need more resources.
How else can we ensure that transparency, access and competition are a reality and not something just in the rulebooks? With 670 people, we are only 36 people more than 20 years ago, and we’ve got a whole lot more to do. The futures market has grown significantly, and we now also oversee the swaps market, which is ten times the size in open interest and far more complex.
In the face of these new responsibilities, the CFTC already has shrunk 6 percent. Further, we were forced to notify employees of an administrative furlough for up to 14 days this fiscal year.
This isn’t good for the American public. This isn’t good for the branding of the markets or your businesses.
Third, 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 readily and pervasively rigged.
This will mean changes in both the futures and swaps markets, as nearly 70 percent of the futures market references LIBOR and two-thirds of the swaps market references LIBOR or Euribor. The work of the Financial Stability Board to find alternatives and consider potential transitions to these alternatives is critical.
Fourth, 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 and making appropriate proposals regarding automated and high frequency trading.
Fifth, I believe it’s appropriate for the CFTC to seek public comment on a futures block rule proposal. Earlier this year, the Commission finalized a block rule for swaps. To preserve the pre-trade transparency that has been a longstanding hallmark of the futures market, it is critical to do so for futures as well.
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 futures in an effort to bring much-needed reform to the swaps market.
On a personal note, I want to thank the CME and Terry Duffy. I first met Terry in 2007 at a dinner he hosted at Morton’s Steakhouse in Chicago. We agreed on many things that evening. That’s actually been the case ever since. We’ve had some differences, but by in large, we’ve had the same goal: bringing transparency, access and competition to the markets.
I look forward to your questions.
Last Updated: November 19, 2013