February 28, 2011
Good afternoon. I thank Robert Weissman for that kind introduction as well as Public Citizen for inviting me to speak today.
The 2008 financial crisis left us with many lessons and many challenges to tackle. At the Commodity Futures Trading Commission (CFTC), we swim in the derivatives lane. In July of last year, Congress passed – and the President signed – the Dodd-Frank Wall Street Reform and Consumer Protection Act to, among other things, bring the unregulated over-the-counter derivatives markets under comprehensive regulation. Those derivatives, also known as “swaps,” were not the only cause of the 2008 financial crisis, but they played a significant role.
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 (SEC) to bring similar features to the swaps and securities-based swaps markets. We are in the midst of the rule-writing process to fulfill Congress’s direction.
CFTC Background and Funding Needs
The CFTC is charged with overseeing the commodity futures markets. This includes contracts on agricultural commodities, such as wheat, corn and cotton. It also includes energy and metals commodities, such as crude oil, heating oil, gasoline, copper, gold and silver. Lastly, it includes contracts on financial products, such as interest rates, stock index futures and foreign currency. These markets – and our regulatory oversight – affect tens of thousands of farmers, ranchers, oil producers, corporations and anybody else who wants to hedge a risk and get the benefits of transparent pricing in competitive markets.
To fulfill our statutory responsibilities to continue overseeing these markets, as well as to take on oversight of the swaps markets, the CFTC requires adequate funding. Now is the time to invest in oversight of the derivatives markets for our key commodities, including agricultural, energy and metal commodities, as well as financial products.
The CFTC is a good investment for the American public, overseeing vast markets with a relatively small staff. The agency peaked in staff in the early 1990s, but staff levels were cut nearly 25 percent in the early 2000s to our lowest level in 2007 and 2008. With the help of Congress, CFTC staffing levels just this past year returned to our staff levels of the late 1990s – the level needed to oversee the commodity futures markets at that time.
At this point in the agency’s history, the commodities and futures markets have grown substantially, and the agency has been tasked with overseeing a new market. The futures market that the CFTC regulates has grown more than fivefold since the late 1990s to a notional value of about $40 trillion. The swaps market that the Dodd-Frank Act tasks the CFTC with regulating has a notional value of close to $300 trillion. Thus, we need a significant new investment to adequately fulfill our mission. At current funding levels of $169 million, the agency is small compared to the industry it regulates.
The CFTC’s resources are used primarily on staff and technology. Unlike other Federal agencies, we do not have grant programs. We currently have 676 thoughtful, experienced and hardworking staff who are dedicated to the agency’s mission. But staff is not enough. Last year, we used about 18 percent of our budget on technology initiatives. The futures market has evolved to one that is primarily electronic and one that increasingly involves algorithmic trading. There are approximately 12 million contracts traded every day. The CFTC needs to make further investment in technology to efficiently oversee both the futures and swaps markets. It is essential that we have sufficient funding to invest in technology such as automated surveillance. Only through investment in the CFTC will we be able to adequately oversee the commodities, futures and swaps markets and protect the American public.
In fiscal year 2011, faced with a continuing resolution, we have not been adding to our staff, and we’ve unfortunately had to cut back on technology. Effective oversight of the markets, though, requires that we invest in both. The President’s fiscal year 2011 budget request had envisioned a significant increase in technology funding as well as an increase in staff. His fiscal year 2012 budget request of $308 million includes a doubling of the CFTC’s technology budget, coupled with a 45 percent increase in staff, so that we can best police the markets.
If the CFTC’s funding were to return to the fiscal year 2008 level of $112 million, when we were near our lowest staffing levels with just about 440 people, the agency would be unable to fulfill its statutory mission. Every program would be affected, including market surveillance, industry oversight and enforcement. We would be unable to pursue fraud, such as Ponzi schemes, or market manipulation. We would inevitably develop a backlog of registration applications, rule reviews and appellate filings. This would leave significant uncertainty in the marketplace. I am hopeful that the CFTC will be adequately funded at the level requested by the President so that we can fulfill our mission to promote transparent, open and competitive markets. The CFTC is a cop on the beat that ensures markets in commodities and derivatives are protected from fraud, manipulation and other abuses.
The Dodd-Frank Act includes essential reforms to 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. The second type of transparency is to the public.
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 (SEFs).
Exchanges that trade securities or futures allow investors, hedgers and speculators to meet in a transparent, open and competitive central market. Exchanges and swap execution facilities, which are a new type of swaps trading platform created by the Dodd-Frank Act, will be required to provide the marketplace with pre-trade transparency. The Dodd-Frank Act requires standardized swaps – those that are cleared and made available for trading – to be traded on these venues. The Act includes exceptions from this requirement for block trades and transactions involving commercial end-users. Exchanges and SEFs allow buyers and sellers to meet in an open, centralized marketplace, where prices are made publicly available.
The second phase occurs immediately after the transaction takes place, when pricing data is made public in real time. Congress also has been very specific that market participants and end-users should benefit from such real time reporting. This post-trade transparency – other than for block trades – 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.
The third phase occurs over the lifetime of the swap contract. The Dodd-Frank Act requires that swaps be marked to market every day until they expire and that such valuations be shared with market participants. If the contract is cleared, the clearinghouse will be required to publicly disclose the pricing of the swap every day. If the contract is bilateral, swap dealers will be required to share mid-market pricing on a daily basis with their counterparties.
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. 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
The Dodd-Frank Act requires that SEFs give multiple market participants the ability to execute an order with multiple participants. The statute also requires SEFs “to provide market participants with impartial access to the market.” The CFTC’s proposed 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 trade that swap. Furthermore, the proposed rule provides that any market participant that meets minimum financial requirements and fitness standards will have access to the SEF. This access 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. To fulfill that requirement, the CFTC has proposed rules on clearinghouse participant eligibility requirements that 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 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 trading platforms 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.
Before I close, I will take a moment to discuss position limits. Since 1936, the Commodity Exchange Act has prescribed position limits to protect against the burdens of excessive speculation, including those caused by large concentrated positions. The CFTC does not set or regulate prices. Rather, the Commission is directed to ensure that commodity markets are fair and orderly.
When the CFTC set position limits in the past, the agency sought to ensure that the markets were made up of a broad group of market participants with a diversity of views. At the core of our obligations is promoting market integrity, which the agency has historically interpreted to include ensuring markets do not become too concentrated. Position limits help to protect the markets both in times of clear skies and when there is a storm on the horizon.
The CFTC voted in January to propose position limits in the agriculture, metal and energy markets. That rule is out for comment, and I encourage you and all members of the public to submit views on the rule.
We can’t lose sight of the fact that we had a financial crisis in 2008. Congress responded and determined that significant changes must be made to market regulation to bring transparency, lower risk and help prevent the next crisis. We are working now to implement those reforms. As we do so, it is important to note that the CFTC’s rule-writing benefits significantly from the public comment process. I encourage you and all members of the public to submit your views regarding our proposed rules. These comments help Commissioners and staff as we prepare final rules.
Thank you for inviting me to speak today.
Last Updated: February 28, 2011