September 28, 2010
Good morning. I thank the Belgian E.U. Presidency and Eurofi for inviting me to speak this morning on regulatory reform of over-the-counter (OTC) derivatives, or swaps, markets. I also want to thank Commissioner Michel Barnier for his open invitation to come to Brussels to continue our partnership and coordination on these issues. Lastly, I want to thank each of my fellow CFTC Commissioners and our staff for all of their hard work.
This is my third trip to Brussels since last September. As the crisis once again so proved, capital and risk know no geographic boundaries. We are partners in the global effort to lower risk throughout our economies.
In 2008, both the financial system and the financial regulatory system failed. Though there were many causes of the crisis, as evidenced by the $180 billion that U.S. taxpayers put into an ineffectively regulated AIG, derivatives did play a significant role. Over-the-counter derivatives – initially developed to help manage and lower risk – can actually concentrate and heighten risk in the economy and to the public.
Today, I will discuss what we are doing in the United States to increase transparency and lower risk in the OTC derivatives marketplace. I also will address these efforts in the context of the proposal recently released by the European Commission.
In July, the U.S. Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which included three important priorities:
• It brings comprehensive regulation to OTC derivatives dealers.
• It requires standardized derivatives to be cleared by regulated clearinghouses.
• It requires standardized derivatives to be traded on transparent exchanges or swap execution facilities.
Two weeks ago, the European Commission released its proposal on OTC derivatives, central counterparties and trade repositories. As we had, the E.C. also covers the entire marketplace – both bilateral and cleared – and the entire product suite, including interest rate swaps, currency swaps, commodity swaps, equity swaps and credit default swaps. It is clear that the partnership between the U.S. and Europe is bearing fruit. Though we have different political systems and different cultures, our coordination and cooperation on financial regulatory reform is leading to two largely consistent approaches.
Regulating the Dealers
Both the Dodd-Frank Act and the E.C.’s proposal have strong capital and margin, or what you refer to as collateral, requirements for derivatives dealers. This is so necessary to help lower risk. They also both have reporting requirements to swap data repositories so that regulators around the globe for the first time can see a transparent picture of the transactions and positions in this marketplace. The U.S. statute says that information in swap data repositories that we regulate should be available to foreign regulators. It will be incumbent as we write rules that we ensure such global access. We look forward as well to working with our international counterparts on arrangements to ensure that necessary data in swap data repositories be available to foreign regulators.
The Dodd-Frank Act also explicitly authorizes the CFTC and the Securities and Exchange Commission (SEC) to write business conduct standards to lower risk and promote market integrity. Though the E.C. has not explicitly taken up business conduct standards for derivative dealers in its proposal, it has recommended important risk mitigation techniques that are in line with key aspects of the U.S. approach.
We will be looking to ensure the timely and accurate confirmation, processing, netting, documentation and valuation of all transactions. These standards for “back office” functions will help reduce risks by ensuring derivative dealers, their trading counterparties and regulators have complete, accurate and current knowledge of their outstanding risks. I look forward to coordinating with the newly approved European Securities Market Authority (ESMA) as we draft our business conduct rules and as ESMA considers similar standards.
Further, the Dodd-Frank Act says that we must write business conduct rules to protect against fraud, manipulation and other abuses. We are to establish heightened standards regarding certain entities using off-exchange derivatives, such as municipalities and pension funds. I recognize that you have had similar issues in Europe. We have certainly had them in the U.S. Business conduct standards will help lower risk for these entities. We’ll be consulting on aspects of the E.C.’s Markets in Financial Instruments Directive (MiFID) review that may deal with similar provisions related to municipalities and pension funds.
Lowering Risk through Central Clearing
Another area where the U.S. and Europe have a strong partnership is requiring clearing of standardized derivatives – those derivatives that Americans call “clearable” and that Europeans often called “eligible.” Clearinghouses in the futures markets – or what you may refer to on-exchange derivatives – have been around since the late-19th century. They have functioned both in clear skies and during stormy times – through the Great Depression, numerous bank failures, two world wars and the 2008 financial crisis – to lower risk to the economy. We both recognize the need for very robust risk management standards, particularly as more swaps are moved into central clearinghouses.
As we write rules regarding the clearing requirement, our staff is looking closely to the European proposal to ensure consistency. We also are looking into how to best incorporate the newest draft CPSS-IOSCO standards for central counterparties into our rules. Even as both the U.S. and Europe have debated how to best balance lowering risk through central clearing with the concerns of corporate end-users of derivatives, we have come out quite similarly. In both the Dodd-Frank Act and the E.C.’s proposal, non-financial entities that are using swaps to hedge or mitigate commercial risk will be able to choose whether or not to bring their swaps to clearinghouses. In both proposals, however, financial entities, such as swap dealers, hedge funds and insurance companies, will be required to use clearinghouses when entering into standardized transactions with other financial entities.
The third critical reform that the Dodd-Frank Act brings to the off-exchange derivatives marketplace is a strong requirement that standardized swaps be traded on exchanges or similar swap execution facilities. The Dodd-Frank Act also brings post trade transparency to the swaps market by requiring real time reporting for both cleared as well as bilateral swaps. I understand that in Europe, you plan to address the transparency requirement later when you take up possible reforms to MiFID. Let me just say a few words at this time on the importance of bringing transparency to the public and not just to regulators.
The more transparent a marketplace is to the public, the more liquid it is, the more competitive it is and the lower the costs for companies using derivatives to hedge risk. Importantly, transparent trading also gives clearinghouses reliable pricing to best manage their risk.
With Dodd-Frank, the Congress extended our position limit authority to apply to off-exchange derivatives. We have used position limit authority since the 1930s to protect the markets from the burdens that may come from excessive speculation. It is important that regulators have the authority to set position limits on both physical commodities derivatives as well as credit default swaps. These authorities, along with new anti-manipulation authorities, will allow us to better protect against abusive practices in the CDS market.
Before I conclude, I’d like to spend a moment addressing how we are approaching implementing the Dodd-Frank Act. At the CFTC, we have organized our rule-writing efforts around 30 teams. Each team is responsible for writing rules on one segment of the bill as it relates to derivatives regulation. We generally have 360 days to implement these regulations. For those of you keeping track, that means we have 291 days left.
Two principles are guiding us throughout the rule-writing process. First is the statute itself. We intend to comply fully with the statute’s provisions and Congressional intent to lower risk and bring transparency to these markets.
Second, we are consulting heavily with both other regulators and the broader public. We are working very closely with the SEC, the Federal Reserve and other prudential regulators. Similarly, we are working very closely with our counterparts in Europe. In fact, the day that the E.C. released its proposal on off-exchange derivatives, I emailed staff from my blackberry and directed them to refer to the new European proposals as we seek consistency in our regulatory approaches. Patrick Pearson of the E.C. recently said that his office’s phone bill to the U.S. has never been higher.
We also are soliciting broad public input into the rules. We have encouraged this through our website, through joint roundtables with the SEC and through individual meetings. In the last 10 weeks, we have had at least 141 such meetings, a list of which – including the participants and issues discussed – is available on our website.
We plan to actively propose rules in the fall, using weekly public Commission meetings for this purpose. We will ask the public to comment directly on these proposals. We plan to finalize our rules by July 15, 2011.
Working with regulators from around the world, I am confident that we will bring robust, consistent regulation to the off-exchange derivatives marketplace. With the significant majority of the worldwide OTC derivatives market being conducted in the U.S. and Europe, the effectiveness of reform depends on our ability to cooperate and find general consensus on this much needed regulation.
Thank you for inviting me to be with you today.
Last Updated: January 18, 2011