February 4, 2011
Good afternoon. I thank the American Bar Association’s Committee on Derivatives and Futures Law for inviting me to speak today. Unfortunately I am not able to join you in person. The CFTC currently is operating under a Continuing Resolution, which means that our funding is the same level as it was last fiscal year. Thus, we are limiting travel.
The 2008 financial crisis left us with many lessons and many challenges to tackle. When I addressed this audience last year, I focused on two of those challenges: lowering risk in the derivatives markets by requiring centralized clearing of standardized transactions and improving transparency in those markets through trading on exchanges and swap execution facilities. Since then, Congress passed – and the President signed – the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act includes clearing and trading requirements and brings swap dealers under comprehensive regulation. Today, I will spend my time addressing the CFTC’s efforts to implement the Dodd-Frank Act.
Markets work best when they are transparent, open and competitive. The American public has benefited from these attributes in the futures and securities markets since the great regulatory reforms of the 1930s. In enacting reforms after this generation’s financial crisis, Congress directed the CFTC and the Securities and Exchange Commission to bring similar features to the swaps markets. We are in the midst of the rule-writing process to fulfill Congress’s direction.
The Dodd-Frank Act includes essential reforms that bring sunshine to the opaque swaps markets. Economists and policymakers have for decades recognized that market transparency benefits the public. The more transparent a marketplace is, the more liquid it is for standardized instruments, the more competitive it is and the lower the costs for hedgers, borrowers and, ultimately, their customers.
There are two types of transparency that Congress sought to bring to the swaps markets. The first is transparency to the regulators, which will include swap data repositories that will provide data to regulators in real time. The second type of transparency is to the public, which I will focus on today.
There are three phases that a swap transaction goes through that will be more transparent under the Dodd-Frank Act. The first occurs before the transaction takes place by moving standardized swap transactions onto exchanges or swap execution facilities. The second is immediately after the transaction occurs, when pricing data must be made public. The third is during the life of the swap contract. The Dodd-Frank Act requires that swaps be marked to market every day of their lifetime and that such valuations be shared with market participants.
Exchanges that trade securities or futures allow investors, hedgers and speculators to meet in a transparent, open and competitive central market. The Dodd-Frank Act enables futures exchanges to also offer swaps for trading and establishes a new category of trading platforms, called swap execution facilities (SEFs), than can only trade swaps.
Exchanges and swap execution facilities provide the marketplace with pre-trade transparency. The Dodd-Frank Act requires standardized swaps – other than block trades – to be traded on these venues. Exchanges and SEFs allow buyers and sellers to meet in an open, centralized marketplace, where prices are made publicly available. The CFTC’s proposed rules provide flexibility to market participants whereby they can make requests for quotes; make indicative quotes; and make firm bids and offers to other market participants.
Real Time Reporting
Congress also has been very specific that market participants and end-users should benefit from real time reporting. Such post-trade transparency must be achieved “as soon as technologically practicable” after a swap is executed, which will enhance price discovery. This requirement applies to both cleared and uncleared swaps. Just as in the futures marketplace, block trades for swaps will be reported with some delay.
One of the key chapters from the 2008 financial crisis was when large financial players, including AIG, had valuation disputes. The Dodd-Frank Act directly addresses many of these issues by requiring daily valuation of swaps over the lifetime of the contracts. For cleared swaps, clearinghouses have to publicly say where they are marking their positions. For uncleared swaps, swap dealers and major swap participants have the obligation to provide the mid-market pricing of outstanding swaps to their counterparties on a daily basis. Furthermore, when swap dealers and major swap participants are valuing the swaps, our proposed rulemaking requires those entities to use as objective data as possible, such as settlement prices as reported by clearinghouses.
In addition to transparency requirements on individual swap transactions, the Dodd-Frank Act requires additional transparency on the market in aggregate. Both trading venues and clearinghouses will have to provide aggregate trading data to the public on a daily basis. Trading venues will be required to make aggregate data available on trading volume, open interest and pricing. Clearinghouses will be required to make aggregate data available on daily trading volume, open interest and mark-to-market settlement prices. The CFTC also is required to publish a regular report on trading and clearing by swap categories. The Dodd-Frank Act requires that data to be released at least every six months, but we hope to release data more frequently than that. We are looking to promote the transparency of the swaps market in ways similar to what we have done for many years through aggregate reporting of futures trading data.
A significant benefit that transparency brings to the marketplace is increased competition. But transparency is not enough. The Dodd-Frank Act also has provisions to promote competition through access in the marketplace. Competition is essential to well-functioning markets. In passing the Dodd-Frank Act, Congress decided that there should be open access to the swaps markets in a number of key ways.
Impartial Access to SEFs
In establishing SEFs, Congress required that trading platforms give multiple market participants the ability to execute an order with multiple participants. SEFs also must give all potential traders the ability to participate, particularly as the statute requires these trading facilities “to provide market participants with impartial access to the market.” The CFTC’s proposed SEF rules require SEFs to allow market participants to leave executable bids or offers that can be seen by the entire marketplace. That means that any market participant – a bank or a nonbank – can choose if they want to take on risk and buy a swap. This brings competition to the marketplace that improves pricing and lowers risk.
Open Access to Clearinghouses
In addition to opening access to trading facilities, the Dodd-Frank Act requires open access to clearinghouses. The CFTC recently proposed rules on clearinghouse participant eligibility requirements to promote fair and open access to clearing. Importantly, the proposal addresses rules of how a futures commission merchant can become a member of a swaps clearinghouse. The proposal promotes more inclusiveness while allowing the clearinghouses to scale a member’s participation and risk based upon its capital. This improves competition that will benefit end-users of swaps, while protecting clearinghouses’ ability manage risk.
Non-Discriminatory Open Access to Clearinghouses
Congress also passed an important provision to promote competition amongst swaps trading platforms that requires clearinghouses to provide non-discriminatory open access. This means that clearinghouses will have to accept equivalent swaps for clearing regardless of where the transaction was executed. This includes both swaps that are executed bilaterally and those on unaffiliated trading platforms. We’ve incorporated this requirement into proposed rulemakings. It will promote competition in and amongst trading platforms. This is not required in the futures world.
We are approaching the end of the proposed rulemaking phase of implementing the Dodd-Frank Act. As we near completion, I would like to encourage you and your clients – as well as all members of the public – to continue submitting comments on each of the rules. The feedback we have received from the public both before writing rules and in response to the proposed rules has been incredibly helpful to the agency, and we hope to continue receiving more.
I’d like to highlight a question that we’ve raised in many of our individual rulemakings relating to the timing for the implementation of various requirements under these rules. The Commission would benefit from the public’s views – including the views of everyone in this room – on the best way of phasing in these requirements.
There are a lot of new requirements that dealers and end-users will be looking through in our proposed rulemakings. This includes possible operating changes they may need to implement to comply with new regulations. In looking across the entire set of rules, public comments will help inform the Commission as to what requirements can be met sooner and which ones will take a bit more time. So as part of seeking public comment on each of the individual rules, it would be helpful to get the public’s feedback regarding the phasing of implementation.
Last week CFTC staff held a roundtable on swap data recordkeeping and reporting requirements to solicit additional input from the public. The transcript from the roundtable was added to the public comment file and will be helpful when staff and the Commission work on a final rulemaking. We are considering hosting additional similar roundtables so that we can continue to benefit from the public’s input.
As we are concluding the proposed rulemaking phase of Dodd-Frank implementation, we will consider rulemakings that include conforming amendments to rules already proposed by the Commission. We’d like to hear your comments on these rules as well. The process benefits from robust public participation.
In conclusion, the American public benefits most when markets are transparent, open and competitive. The U.S. swaps market today does not have these features. Rather, it has been opaque and concentrated amongst a small group of dealers. It was the intent of Congress in passing the Dodd-Frank Act to bring diversity and sunshine to the market. It is our mission at the CFTC to fulfill Congress’s mandate.
Thank you for inviting me to speak today.
Last Updated: February 4, 2011