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  • Keynote Address of CFTC Commissioner J. Christopher Giancarlo before the 2015 ISDA Annual Asia Pacific Conference

    Top-Down Financial Market Regulation: Disease Mislabeled as Cure

      October 26, 2015

    Introduction

    Good morning, ladies and gentlemen. Thank you for your warm welcome. It is a pleasure to be with you today.

    Before I begin, let me say that my remarks reflect my own views and do not necessarily constitute the views of the Commodity Futures Trading Commission (CFTC or Commission), my fellow CFTC commissioners or the CFTC staff.

    In June of this year I celebrated my first anniversary as a commissioner of the CFTC. As a new market regulator and a long-standing supporter of thoughtful swaps market reform, I have met with fellow global financial regulators in Washington, Chicago, New York, Geneva, London, Shanghai, Beijing and Hong Kong. I have spoken to and heard from market participants in the U.S., Europe and Asia, from hedge funds to large corporations, from commodities traders to major money center banks and from futures exchanges to swap execution facilities. I have also met with many energy and agricultural derivative end-users, such as coal miners, oil refiners, natural gas producers and electricity utility operators, dairymen, crop farmers and heavy equipment manufacturers.

    Before being sworn in as a commissioner, I served for thirteen years as a senior executive of a leading operator of electronic and hybrid trading platforms for cash and derivative products. In that role, I helped build a global business that fosters trading liquidity for thousands of institutional clients in instruments from corporate fixed income to interest rates, foreign exchange, equities, energy and commodities.

    Thus, my business experience in global markets combined with my current role at the CFTC informs my approach to the major challenges facing financial regulators today. That approach seeks to enhance the health, vibrancy and resiliency of markets. My concern is the ability of financial markets to durably and fairly serve their core constituencies: entrepreneurs and capital raisers, risk hedgers and speculators, retail investors and end-users, savers and retirees.

    I want to first address two topics that I think are of keen interest to today’s audience, in particular, and participants in the global swaps markets, in general. Those are the changing dynamics of market trading liquidity and margin on inter-affiliate transactions in uncleared swaps. I then wish to comment broadly on two areas of interest to the CFTC and my fellow commissioners: automated trading and cyber threats.

    Constrained Trading Liquidity

    Let me first discuss market liquidity.

    Market participants well know that liquidity is the lifeblood of healthy trading markets. In essence, liquidity is the degree to which a financial instrument may be easily bought or sold with minimal price disturbance by ready and willing buyers and sellers. Quantifying liquidity is challenging, but not impossible. It is often easier to qualify it through a range of characteristics such as market depth, width, volume, resiliency, immediacy, participation and turnover.

    Today, it is increasingly apparent that a number of these liquidity characteristics have been fundamentally changed in many asset classes and financial markets and, in key market sectors, adversely impacted.1 Accounts of market illiquidity extend from U.S. Treasury securities2 to German Bonds,3 corporate bonds,4 equities,5 U.S.6 and euro7 interest rate swaps, single name credit default swaps (CDS),8 cross-currency swaps,9 repos10 and energy swaps and futures.11

    Concerns about the diminishment of trading liquidity have been voiced by the International Monetary Fund (IMF),12 the Bank for International Settlements (BIS),13 the Bank of England,14 Federal Reserve Chairwoman Janet Yellen,15 financier Stephen Schwarzman of Blackstone16 and noted economist Nouriel Roubini.17 While some central bankers express skepticism over a lack of quantitative evidence of illiquidity,18 there is real concern among those with actual financial market responsibility and knowledge, including financial market regulators19 and important market participants.20

    We saw evidence of such pronounced liquidity contraction this past August in enormously volatile equity markets, when major global banks focused on executing trades for their clients rather than for their own account.21 We saw it in June with sudden spikes in the German Bond market.22 We saw it a year ago when the market for U.S. Treasury securities, futures and other closely related financial markets experienced an unusually high level of volatility and a very rapid and pronounced round-trip.23

    A few days ago, Chairman Massad cited new CFTC research showing that “flash” volatility spikes have become increasingly common, with 35 spike events so far this year in core futures products such as corn, gold, WTI crude oil, E-Mini S&P and Euro FX.24 This is a clear confirmation of the now-undeniable changes in market liquidity and increased volatility that have come about in this new era of macroprudential regulation.

    Traditionally, large global money center banks served to reduce such market volatility by buying and selling reserves of securities or other financial instruments to take advantage of short-term anomalies in market prices.25 Their balance sheets served as market “shock absorbers” in times of market turbulence.

    Now, that seems to be a thing of the past. Throughout these recent sharp volatility episodes, banks appear to have been unable to step in aggressively to provide additional trading liquidity.26 Banks have also reduced market services, further diminishing market liquidity, jettisoning less-profitable clients and increasing some fees on others in such areas as prime brokerage27 and as futures commission merchants (FCMs).28 “Wall Street’s role as an intermediary and risk taker has shrunk,” according to one senior banker.29 This evolution appears to have been underway for some time.30

    Instead, market professionals in the U.S. and abroad point to the presence of “phantom liquidity” available in ordinary market conditions, which disappears when traders look to access it in large volumes in times of sharp volatility.31 The BIS has confirmed the increasing “liquidity illusion” in credit markets.32

    A major – though not exclusive – cause of the reduced bank trading liquidity and volatility spikes in financial markets is the new regulatory policies that U.S. and overseas prudential banking regulators imposed in the wake of the financial crisis.33 Policies such as the Basel III capital requirements and leverage ratios, the Volcker rule's ban on bank proprietary trading, the CFTC’s flawed derivatives trading rules,34 low de minimis levels for swap dealer registration, restrictive position limits proposals and unending edicts from global shadow regulators like the Financial Stability Board prioritize capital reserves over investment, balance sheet surplus over market making, trading friction over efficiency and safety over opportunity.

    Undoubtedly, each of these rulesets is well-intentioned with ostensible merit and supportive constituencies. Many are derived from principles of bank – not market – regulation that seek to control borrowing and leverage and enhance retained capital to reduce broad systemic risk – the so called “macroprudential” approach to regulation. Some of the regulations, such as the Volcker rule, were politically debated before being embodied in legislation. A few are high-level proposals that, although not yet law, still have an anticipatory restraining impact on market participants.

    Yet, each of these regulatory sets has a common impact: increased liquidity risk. Combined, they deprive financial markets of critical liquidity in times of market stress when deep and stable liquidity is most essential.

    Experienced market veterans have openly voiced concerns that the unmeasured wave of regulatory constriction of bank capital will be the cause of a future market crisis.35 The question must be asked whether the regulatorily driven retreat of major banking institutions from active trading in financial markets is the disease of which it purports to be the cure.

    Some contend that new, non-bank entrants into financial markets have sufficiently offset reduced bank trading capital.36 They believe that bank liquidity can be adequately supplemented by proprietary firms using trading algorithms with greater speed, accuracy and transaction volume than traditional bank trading desks.37 Others are less confident that the void of bank trading liquidity can so readily be filled by newer market entrants with far smaller balance sheets that cannot access now-constrained bank capital.38

    Some believe that heightened market volatility is not just a result of prudential regulations constraining bank capital, but also results from the increased presence of automated trading (which I will discuss later on) and the impact of U.S. and European monetary policy, in which market participants have moved into crowded, one-way trading postures in anticipation of changes in central bank moves rather than fundamental analysis.39 Whatever the exact mixture of these factors, the fact of disappearing trading liquidity and sharper volatility will have enormous implications for 21st century markets.

    The current withdrawal of bank capital from financial markets can be likened to a reduction of bio-diversity in an ecosystem. Modern science teaches that bio-diversity supports ecosystem health; its reduction threatens system sustainability. In the case of global financial markets, the diversity of liquidity provision has been clearly reduced, with the growing consequences of market volatility spikes and heightened liquidity risk. This hazards a new form of systemic risk that regulatory reform was meant to mediate.

    We need to understand the full implications of constrained bank capital on growing market volatility. While I sympathize with Chairman Massad’s desire to “resist the temptation to recognize an effect and presume the cause,”40 we must be willing to acknowledge the macroprudential elephant in the room. The relationship between ever-expanding macroprudential bank regulation and increased liquidity risk must be fully and honestly considered.

    We need to view systemic risk reduction as much from the perspective of trading markets as from the perspective of bank balance sheets. We must be willing to question whether the amount of bank trading capital constriction is properly calibrated to the amount of durable liquidity needed to support market health and vibrancy.

    From the perspective of optimal market conditions, has too much bank capital been constrained? Has bank resiliency been enhanced at the expense of market stability? Has the systemic risk of bank insolvency been addressed at the cost of increased market liquidity risk?

    Answers to these questions must be sought by those of us with direct responsibility for overseeing financial markets. It is not an acceptable response to say that concerns over trading liquidity are overblown in markets where proprietary trading firms have supplanted bank capital and then, in the next breath, blame those proprietary firms for causing increased volatility because of the automated trading systems used to generate such liquidity.

    It is also not acceptable to be primarily concerned about Treasury market volatility and simply expect participants in other markets to adapt to increased market volatility as part of the “new normal” alongside the continuing reality of mediocre global economic growth.

    In analyzing heightened market volatility and liquidity risk, we must be willing to honestly question the role of contemporary bank regulation. Only a thorough assessment and, if warranted, course correction will allow global market participants and the American public to be certain of the ability of U.S. and other G-20 financial markets to steadily underpin a return to sorely needed world economic growth.

    Margin on Uncleared Swaps

    I now turn to the matter of margin on uncleared swaps. As you know, the CFTC is working on final rules requiring the posting of margin on uncleared swaps. Getting that rule right is essential to the ability of swaps end-users to cost-effectively hedge business risk across regulatory jurisdictions.

    In April of this year, I testified before the United States House of Representatives Committee on Agriculture.41 In response to a question, I explained that the CFTC’s proposed rules were inconsistent with the European and IOSCO approach of exempting swaps transactions between certain affiliates from initial margin requirements.42  I explained that, as a result, the cost of such initial margin in inter-affiliate transactions will inevitably be passed on to U.S. derivative end-users.  This added cost will discourage end-users from entering into swaps transactions with international swaps dealers that, in turn, look to offset the hedge in markets outside of the United States. 

    If the CFTC is unwilling to exempt dealer affiliates from having to post initial margin on uncleared swaps, it will have two adverse impacts on U.S. end-users:  First, it will subject them to higher costs and wider bid/offer price spreads; and second, it will have the effect of ring-fencing financial risk in the U.S. by increasing the costs of risk hedging in broader global markets. So, against the assertion that the CFTC’s proposed rules on inter-affiliate margin will serve as a barrier to importing risk into the U.S., is the realization that the rules will serve to encapsulate risk in the U.S. marketplace, increasing, rather than decreasing, systemic hazard in American financial markets. 

    Top-Down vs. Bottom-Up Regulation

    I want to preface my following remarks on algorithmic trading and cyber security with compliments to my two fellow commissioners, Chairman Tim Massad and Commissioner Sharon Bowen. Both of them have publicly discussed these topics, underlining their importance with thoughtful ideas and comments. It is a professional pleasure to work with such intelligent and constructive colleagues.

    Where I differ with my CFTC colleagues – and it is fundamental – is in my view of the appropriate impetus of market change and evolution.

    You see, I am a skeptic of top-down, rules-based Washington mandates. Such mandates are prone to failure because they rely on bureaucratic planning and guesswork and lack an adequate understanding of the global marketplace and direct price signals to guide decision making.43 Government action is rarely a catalyst for change; it is more often a force for inertia, waste and favoritism.

    Rather, I favor bottom-up, principles-based market solutions. I believe that markets themselves, reflecting the myriad actions of the broad sway of participants, remain the most efficient agents of change known to humankind.

    Automated Trading

    This market-based approach guides my perspective on a topic of current attention by the CFTC: automated trading.

    Without a doubt, the electronification of financial markets over the past 30 to 40 years and the advent of exponential digital technologies are transforming financial businesses, markets and entire economies, with dramatic implications for capital formation, risk transfer and human society.

    At the CFTC, we see this transformation most presently in the area of algorithmic or automated trading. Automated trading now constitutes approximately 70 percent of regulated futures markets,44 and I expect that it will continue to dominate trading in futures markets with new and innovative developments for many decades to come. For trading firms, automated trading can lower transaction costs while increasing trader productivity through greater transaction speed, precision and sophistication. For many markets, automated trading brings trading liquidity, broader market access, enhanced transparency and greater competition. Such features are all the more beneficial in the wake of departing bank liquidity.

    How global market regulators in markets such as New York, Chicago, London, Hong Kong and Shanghai handle this change from human to automated trading will be extremely important. In my view, we must be careful to cultivate and embrace new technologies without harming innovation. There is no doubt there must be safeguards in place, but those safeguards should not stifle promising innovation.

    As has been reported,45 the staff of the CFTC has been working on a rule proposal regarding regulation of automated trading. Much of the public’s views on how the CFTC should approach automated trading are expressed in comment letters formally submitted to the Commission in response to an important concept release issued in September 2013.46

    I fully agree with the many commentators who advocate for a principles-based approach to CFTC regulation on automated trading.47 In this time of rapid technological innovation, any hard and fast regulatory specifications or restrictions on automated trading will be obsolete by the time they are published in the Federal Register. The only effective way for a regulatory agency to stay ahead of the rapid advances of trading automation is to be informed through an ongoing bottom-up process. That is, through industry working groups composed of leaders of automated trading firms setting industry best practices and procedures. Such best practices should then be set as universal standards by the futures markets self-regulatory organizations (SROs), such as the National Futures Association (NFA) and the Chicago Mercantile Exchange. To be effective, any new CFTC regulatory framework for automated trading must be structured such that principles are constantly informed by technological innovation and industry best practice, not media headlines, best-selling books or political agendas.

    I understand that there are a number of requirements for specific risk controls that the CFTC staff may wish to impose on automated trading firms. They may include pre-trade risk controls, limits on self-trading and order cancellation mechanisms or “kill switches.” Yet, I also understand that many automated trading firms and emerging industry best practices already support such procedures and controls.48 Any new regulatory principles adopted by the CFTC need to enhance, not stifle, industry and market-level innovations and improvements in such risk controls.

    The CFTC may also seek to set standards for algorithm development and testing, staff training, and trade monitoring, compliance and reporting. In this area, I believe the SROs may be more proximately placed than the CFTC to surveil, oversee and report to the CFTC the operation and performance of automated trading systems in the futures marketplace. I can flatly state that I will not support any proposal for the CFTC to pre-test algorithms or pre-approve automated trading strategies before they can be deployed in trading markets. I will also not support a framework that is not technologically neutral or that stifles beneficial market innovation. In addition, any proposal to “inspect” algorithms must be carefully considered due to the cyber security risks associated with giving the government access to trading firms’ source codes.

    In short, I recognize the public interest in having automated trading firms utilize risk controls and market practices that are constantly updated to the highest optimization in the constantly evolving futures markets of today and tomorrow. The question is how to achieve it – top-down or bottom-up? I prefer an approach that is informed by market innovation over one that is political narrative-based and Washington-mandated.

    Cyber Security

    Lastly, but certainly not least, let me address cyber security.

    We all know that cyber security is critically important to protecting infrastructure and financial markets around the world. Recently, my colleague, CFTC Chairman Tim Massad, noted that cybersecurity is the most important single issue facing our markets today in terms of market integrity and financial stability.49 I fully agree.

    And such attacks are directed at every important financial marketplace across the globe.50 As market leaders and regulators, we must leave no step untaken or precaution unavailed to thwart cyber-attacks on the world’s financial markets. The cyber threat must have first priority over our present time and attention.

    For this reason, I believe any regulatory approach to cyber security that is primarily driven top-down will be a recipe for failure. Rather, the right approach must be a close and dynamic relationship between competent national cyber defense agencies and private-sector enterprises.

    We should certainly look to emerging industry best practices. For example, the rapidly growing cyber risk insurance market is driving some of the best innovations in private-sector cyber-attack defense and preparedness.51 Firms like Chubb, ACE and Marsh & McLennan are partnering with knowledgeable cyber security firms to develop new insurance products.52 Cyber risk insurance has a growing presence in the online retail and social network industries, but is just beginning to grow in financial services.53 The risk assessment process and underwriting costs of cyber insurance incentivize firms to invest appropriately and efficiently in up-to-date security measures.54

    Another instructive private-sector development is the increasing retention of “C-Suite” level, dedicated network security officers. I agree with my colleague Sharon Bowen55 that such practice should be more widespread among major financial and derivatives market participants. Yet, I note that the CFTC itself lacks such a dedicated officer. I would find it hard to expect firms under CFTC supervision to create an office that the CFTC itself does not deem essential.

    Moreover, insurance risk assessment and C-Suite officers do not by themselves meet the constantly changing needs of cyber risk. I believe what is needed is drive and determination from marketplace leaders and operators. Those that have the most to lose from cyber-attacks – the commercially operated exchanges, the other self-regulatory bodies, the major banks and trading firms and the FCMs – must show strong leadership. They have every economic incentive to develop standards, principles and best practices for cyber protection based on the best available current data.

    In this regard, I commend the adoption by the NFA of a new Interpretive Notice on information security programs.56 The Interpretive Notice requires member firms to adopt and enforce written procedures to secure customer data as well as access to the member’s electronic systems, while providing flexibility in design and implementation. The suggested procedures are in line with written guidance issued by other financial regulatory entities and associations such as the U.S. Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA) and the Securities Industry and Financial Markets Association (SIFMA).57

    Prior to adopting the Interpretive Notice, NFA also received input from its various member advisory committees. I support this type of “bottom-up” informed approach to marketplace obligations. Our job, as regulators, is to encourage it, support it, inform it and empower it. We must provide lots of regulatory “carrots” and the occasional regulatory “stick” to help our market participants innovate, inculcate and disseminate cyber defense strategies and tactics as fast as the bad guys come up with new forms of attacks.

    The worst thing we can do as regulators is to impose dated mandates on firms that consume precious resources responding to last year’s dramatic cyber-attack, causing them to miss the attack that will happen tomorrow. Again, what is required is a bottom-up approach.

    So, now I will put on my old business executive hat and ask a question one asks every day in the private economy: how can we add value? How can the CFTC assist the businesses it regulates in maximizing their cyber defenses? How can the CFTC ensure our regulated firms, including our important futures exchanges, have up-to-date information about the latest cyber threats and attacks and the most effective defensive tactics and procedures?

    I believe one small, but important way the CFTC could add value is by serving as an information resource and communication conduit between regulated firms and the myriad of federal defense and law enforcement agencies, including the alphabet soup of cyber security bureaus. I propose that the CFTC designate a qualified cyber security information coordinator to work with our registered companies to help them navigate the maze of Federal agencies and ensure they have ready access to the most up-to-date cyber security information available.

    Conclusion

    Now that I have just gone against my innate skepticism of government expansion with a proposal for a modest, one-person increase in the federal bureaucracy, let me return to my overarching theme. And that is that the primary concern of market regulators must be the ability of financial markets to durably and fairly serve their core constituencies: entrepreneurs and capital raisers, risk hedgers and speculators, retail investors and end-users, savers and retirees.

    To that end, I believe that financial market regulators must recognize – and take responsibility for – the full ramifications of diminished bank liquidity and recurring volatility spikes. We must also avoid the costly adverse impact on U.S. swaps end-users of requiring affiliates of CFTC registrants to post margin on uncleared swaps. Further, in adopting new regulations for automated trading and cyber risk, we must favor bottom-up, principles-based market solutions over top-down, rules-based government mandates.

    Let me leave you with one final thought – and a broad one at that. Trading markets, whether risk hedging, investment making or otherwise, are essential venues for the exercise of human economic freedom. I believe that economic liberty and free enterprise are essential to the advancement of human society around the globe. I also believe that constraints on markets in the form of Washington-generated rules and regulations must be judged on the extent to which their benefits outweigh the costs to economic activity and opportunity. In the case of the financial market regulations I have discussed today, such an offset of benefits over costs remains far from clear.

    Let us not fail to estimate the real costs of financial regulation on markets that are critical to economic recovery. A return to global economic growth and prosperity depend on it. Let us work together for the good of the markets we serve, our national and regional economies, our families and their futures.

    Thank you.

    1 See generally PWC, Global Financial Markets Liquidity Study (2015), https://www.iif.com/publication/regulatory-report/pwc-global-financial-markets-liquidity-study.

    2 Joe Rennison, U.S. Treasuries Market Faces Liquidity Concerns, Fin. Times, July 29, 2015, http://www.ft.com/intl/cms/s/0/73d3dff4-359f-11e5-bdbb-35e55cbae175.html#axzz3o4eqa7V0; see also Xiao Wang, Market Liquidity Has Been Drained by Regulations, Says DBS Chief, Asia Risk, Sept. 17, 2015, http://www.risk.net/asia-risk/news/2426382/market-liquidity-has-been-drained-by-regulations-says-dbs-chief (quoting Piyush Gupta, Chief Executive Officer, DBS Group).

    3 Lukas Becker & Catherine Contiguglia, Hidden Price Pressures Grow in Euro Swap Market, Risk Magazine, Sept. 8, 2015, http://www.risk.net/risk-magazine/feature/2424383/hidden-price-pressures-grow-in-euro-swap-market; Marius Zaharia, Investment Focus: As Liquidity Shrinks, Bond Trading Becomes a Grind, Reuters, June 12, 2015, http://www.reuters.com/article/2015/06/12/markets-bonds-liquidity-idUSL5N0YX2BG20150612.

    4 Bd. of Governors of the Fed. Reserve Sys., Senior Credit Officer Opinion Survey on Dealer Financing Terms 2 (Sept. 2015), http://www.federalreserve.gov/econresdata/files/SCOOS_201509.pdf; see also Tracy Alloway, Why Would Anyone Want to Restart the Credit Default Swaps Market?, Bloomberg, May 11, 2015, http://www.bloomberg.com/news/articles/2015-05-11/why-would-anyone-want-to-restart-the-credit-default-swaps-market- (“[H]alf a decade of ultralow interest rates has encouraged investors to buy whatever fixed-income securities they can find and then hold on to them tightly. That, along with some new regulation, has arguably contributed to a stark decline in so-called liquidity in the corporate bond market at the exact same time that the market has exploded in size and scale.”); see also BlackRock, Viewpoint: Addressing Market Liquidity 1–2, 4–7, 9–10 (2015), http://www.blackrock.com/corporate/en-gb/literature/whitepaper/viewpoint-addressing-market-liquidity-july-2015.pdf; Huw Jones, BoE Delves Deeper into Asset Managers, Uncertain Market Liquidity, Reuters, Sept. 25, 2015, http://uk.reuters.com/article/2015/09/25/boe-markets-regulations-idUKL5N11V2NP20150925?feedType=RSS&feedName=rbssFinancialServicesAndRealEstateNews; Anthony J. Perrotta, Jr., An E-Trading Treasury Market “Flash Crash?” Not So Fast, Tabb Forum, Nov. 24, 2014, http://tabbforum.com/opinions/an-e-trading-treasury-market-'flash-crash'-not-so-fast.

    5 See Justin Baer, James Sterngold & Gregory Zuckerman, Large Banks Retreat from Trading Frenzy, Wall St. J., Sept. 3, 2015, at C1–C2.

    6 See Peter Madigan, U.S. End-Users are Losers in Swaps Liquidity Split, Risk.Net, Apr. 28, 2014, http://www.risk.net/risk-magazine/feature/2340854/us-end-users-are-the-losers-in-swaps-liquidity-split?amf_cntctid=9444896.

    7 See Becker & Contiguglia, supra note 3.

    8 Based on author’s discussion with market participants. See also Alloway, supra note 4; Michelle Davis & Hugh Son, Deutsche Bank Said in Talks to Sell $250 Billion Swaps Portfolio, Bloomberg, Oct. 8, 2015, http://www.bloomberg.com/news/articles/2015-10-08/deutsche-bank-said-in-talks-to-sell-250-billion-swaps-portfolio.

    9 Callum Tanner, Illiquidity Worries U.K. Insurers in Forex Hedging Switch, Insurance Risk, Aug. 24, 2015, http://www.risk.net/insurance-risk/feature/2422999/illiquidity-worries-uk-insurers-in-forex-hedging-switch.

    10 See Bank for Int’l Settlements, 85th Annual Report 106 (2015), http://www.bis.org/publ/arpdf/ar2015e6.pdf; Ryan Tracy, Banks Retreat From Market That Keeps Cash Flowing, Wall St. J., Aug. 13, 2014, http://www.wsj.com/articles/banks-retreat-from-market-that-keeps-cash-flowing-1407890157.

    11 See CFTC, Transcript: Energy and Environmental Markets Advisory Committee Meeting 108 (July 29, 2015), http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/emactranscript072915.pdf.

    12 Int’l Monetary Fund, Global Financial Stability Report 49–53 (2015), https://www.imf.org/External/Pubs/FT/GFSR/2015/02/index.htm; Joe Rennison, Market Liquidity Warning from IMF, Fin. Times, Sept. 30, 2015, http://www.ft.com/intl/cms/s/0/90154486-66a6-11e5-a57f-21b88f7d973f.html#axzz3noQ5Dicr.

    13 Bank for Int’l Settlements, supra note 10, at 36–40 (citing the increasing “liquidity illusion” in which credit markets appear liquid and well-functioning in normal times, only to become highly illiquid upon market shock).

    14 Jones, supra note 4.

    15 Ian Katz, Yellen Says Regulators Ready to Act as Panel Cites Risks, Bloomberg, May 19, 2015, http://www.bloomberg.com/news/articles/2015-05-19/yellen-says-regulators-ready-to-act-as-panel-cites-market-risks (acknowledging concerns that market liquidity may deteriorate during stressed conditions due to new regulations, among other factors).

    16 Stephen A. Schwarzman, How the Next Financial Crisis Will Happen, Wall St. J., June 9, 2015, http://www.wsj.com/articles/how-the-next-financial-crisis-will-happen-1433891718.

    17 Nouriel Roubini, The Liquidity Time Bomb, Project Syndicate, May 31, 2015, http://www.project-syndicate.org/commentary/liquidity-market-volatility-flash-crash-by-nouriel-roubini-2015-05.

    18 See Lael Brainard, Governor, Bd. of Governors of the Fed. Reserve Sys., Address at the Policy Makers’ Panel on Financial Intermediation of the Salzburg Global Forum on Finance in a Changing World: Recent Changes in the Resilience of Market Liquidity (July 1, 2015) [hereinafter Resilience of Market Liquidity], http://www.federalreserve.gov/newsevents/speech/brainard20150701a.htm.

    19 Michael S. Piwowar & J. Christopher Giancarlo, Banking Regulators Heighten Financial Market Risk, Reuters, July 12, 2015, http://www.reuters.com/article/2015/07/12/column-seccftc-idUSL1N0ZP29520150712; see CFTC, Transcript: Market Risk Advisory Committee Meeting 7–8, 90–101 (June 2, 2015), http://www.cftc.gov/idc/groups/public/@aboutcftc/documents/file/mrac_060215_transcript.pdf; Bank of England, Financial Stability Report 16–17 (2015), http://www.bankofengland.co.uk/publications/Documents/fsr/2015/fsrfull1507.pdf; see also Martin Wheatley, Chief Executive, Financial Conduct Authority, Keynote Speech at the Association for Financial Markets in Europe Annual European Market Liquidity Conference: From Intellectual Certainty to Debate (Feb. 25, 2015), http://fca.org.uk/news/from-intellectual-certainty-to-debate.

    20 See, e.g., Blackrock, supra note 4, at 1–2, 4–7, 9–10; Ira Jersey & William Marshall, Credit Suisse Research, Interest Rate Strategy Focus: Downside of Prudential Regulation: Lower Liquidity 1, 3–5 (2014), https://doc.research-and-analytics.csfb.com/docView?language=ENG&format=PDF&document_id=806169730&source_id=emcsplus&serialid=9at6GBo7ldV8dXh3bzdlAuKzA1cXYVsqj4rTpy%2B66YM%3D; Sarah Krouse, Wall Street Bemoans Bond Market Liquidity Squeeze, Wall St. J., June 2, 2015, http://blogs.wsj.com/moneybeat/2015/06/02/wall-street-bemoans-bond-market-liquidity-squeeze/; Wang, supra note 2.

    21 Baer, Sterngold & Zuckerman, supra note 5, at C1–C2.

    22 See Adam Shell, Bond Rout Continues as U.S., German Yields Hit 9-Month Highs, USA Today, June 10, 2015, http://americasmarkets.usatoday.com/2015/06/10/bond-rout-continues-as-u-s-german-yields-hit-9-month-highs/; Zaharia, supra note 3.

    23 U.S. Dep’t of the Treasury, Bd. of Governors of the Fed. Reserve Sys., Fed. Reserve Bank of N.Y., U.S. Secs. and Exch. Comm’n & U.S. Commodity Futures Trading Comm’n, Joint Staff Report: The U.S. Treasury Market on October 15, 2014, at 1–2, 15–17 (2015), http://www.treasury.gov/press-center/press-releases/Documents/Joint_Staff_Report_Treasury_10-15-2015.pdf.

    24 Timothy Massad, Chairman, CFTC, Remarks Before the Conference on the Evolving Structure of the U.S. Treasury Market (Oct. 21, 2015), at 3, http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-30.

    25 See Baer, Sterngold & Zuckerman, supra note 5, at C1–C2; Roubini, supra note 17; see also Perrotta, Jr., supra note 4.

    26 See, e.g., Baer, Sterngold & Zuckerman, supra note 5, at C1–C2; see also Jersey & Marshall, supra note 20, at 1, 3–4; Ira Jersey & William Marshall, Credit Suisse Research, U.S. Interest Rate Strategy Focus: Diminished Market Depth and the Illusion of Liquidity 1–5 (2015) [hereinafter Diminished Market Depth], https://doc.research-and-analytics.csfb.com/docView?language=ENG&format=PDF&source_id=csplusresearchcp&document_id=1048597451&serialid=QoN9KIR%2B2nFljOXbnHk%2BA8QKXCtNxiPvrXjhRu%2FVPn4%3D.

    27 See, e.g., Justin Baer & Juliet Chung, Goldman Sachs Cuts Roster of Hedge-Fund Clients, Wall St. J., Aug. 4, 2015, http://www.wsj.com/articles/goldman-rethinks-services-it-provides-hedge-funds-1407194493; James Shotter & Daniel Schäfer, Credit Suisse to Shrink Prime Brokerage, Fin. Times, Dec. 7, 2014, http://www.ft.com/intl/cms/s/0/c1e1937e-6c16-11e4-b1e6-00144feabdc0.html#axzz3oJbz1BkQ.

    28 See generally J. Christopher Giancarlo, Commissioner, CFTC, Statement for the Agricultural Advisory Committee Meeting (Sept. 22, 2015), http://www.cftc.gov/PressRoom/SpeechesTestimony/giancarlostatement092215.

    29 Baer, Sterngold & Zuckerman, supra note 5, at C1–C2.

    30 As noted by several commentators at the recent Federal Reserve Bank of New York conference. Conference on the Evolving Structure of the U.S. Treasury Market, Federal Reserve Bank of New York (Oct. 20–21, 2015).

    31 E.g., Diminished Market Depth, supra note 26, at 1–3; Insight: High-Frequency Trading Liquidity Goes Phantom Again, EuroMoney, August 2013 [hereinafter EuroMoney Insight], http://www.euromoney.com/Article/3249777/High-frequency-trading-liquidity-goes-phantom-again.html.

    32 Bank for Int’l Settlements, supra note 10, at 36–40.

    33 See, e.g., Office of Financial Research, Annual Report 30–33 (2014), http://financialresearch.gov/annual-reports/; Int’l Monetary Fund, supra note 12, at 50; Baer, Sterngold & Zuckerman, supra note 5, at C1–C2. The BIS attributes diminished liquidity to banks’ increased Treasury holdings, reduced inventory of non-government securities and new regulatory restrictions placed on their capital use and risk transformation activities. See Jerome H. Powell, Governor, Bd. of Governors of the Fed. Reserve Sys., Remarks Before the Conference on the Evolving Structure of the U.S. Treasury Market (Oct. 20, 2015), http://www.federalreserve.gov/newsevents/speech/powell20151020a.htm (noting that the intensified prudential regulation and supervision of the systemically important banks that are the largest dealers is an important trend that is driving the changing structure of the U.S. Treasury markets).

    34 J. Christopher Giancarlo, Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank (2015), http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf.

    35 See, e.g., Schwarzman, supra note 16.

    36 Tobias Adrian, Michael Fleming, Or Shachar & Erik Vogt, Fed. Reserve Bank of N.Y., Has U.S. Corporate Bond Market Liquidity Deteriorated?, Liberty St. Econ., Oct. 5, 2015, http://libertystreeteconomics.newyorkfed.org/2015/10/has-us-corporate-bond-market-liquidity-deteriorated.html#.ViEiK6MpBaQ; see also Resilience of Market Liquidity, supra note 18 (“[I]f traditional providers of liquidity scale back their activity in response to changes in regulation and market structure, over time, this shift may create incentives for other providers, which are not similarly constrained, to step in.”).

    37 See EuroMoney Insight, supra note 31.

    38 See, e.g., Francesco Franzoni & Alberto Plazzi, What Constrains Liquidity Provision? Evidence From Hedge Fund Trades 1–4, 25–26 (Swiss Fin. Inst., 2015), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2239327&download=yes; Schwarzman, supra note 16; see also Baer, Sterngold & Zuckerman, supra note 5, at C1–C2.

    39 See, e.g., Roubini, supra note 17.

    40 Massad, supra note 24, at 7.

    41 Testimony Before the Subcomm. on Commodity Exchanges, Energy, and Credit of the H. Comm. on Agriculture, 114th Cong. (2015) (statement of J. Christopher Giancarlo, Commissioner, CFTC), https://www.youtube.com/watch?v=5PKgimBED3E; J. Christopher Giancarlo, Testimony Before the U.S. House of Representatives, Committee on Agriculture, Subcommittee on Commodity Exchanges, Energy, and Credit (2015), http://agriculture.house.gov/sites/republicans.agriculture.house.gov/files/images/giancarlo%20testimony.pdf.

    42 Compare Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 79 Fed. Reg. 59,898, 59,904 (Oct. 3, 2014), http://www.gpo.gov/fdsys/pkg/FR-2014-10-03/pdf/2014-22962.pdf (“. . . [T]he Commission [is] proposing to apply the margin requirements to swaps between [CFTC-regulated swap dealers] and their affiliates.”), with Basel Comm. on Banking Supervision & Bd. of the Int’l Org. of Secs. Comms., Margin Requirements for Non-Centrally Cleared Derivatives 21 (2013) (declining to mandate inter-affiliate exchanges of variation and initial margin, noting that such a practice “is not customary” and “would likely create additional liquidity demands”).

    43 Chris Edwards, Policy Analysis: Why the Federal Government Fails, Cato Institute, July 27, 2015, http://www.cato.org/publications/policy-analysis/why-federal-government-fails.

    44 A recent internal report by the CFTC's chief economist looked at over 1.5 billion transactions across over 800 products on CME over a two-year period. It found that the percentage of automated trading in financial futures – such as those based on interest rates, currencies or equity indices – was 60 to 80 percent. But even among many physical commodities, there was a high degree of automated trading, such as 40 to 50 percent for many energy and metals products.

    45 See Francine McKenna, New Rules Coming from CFTC to Protect Market from “Flash Boys,” MarketWatch, Sept. 11, 2015, http://www.marketwatch.com/story/new-rules-coming-from-cftc-to-protect-market-from-flash-boys-2015-09-11.

    46 Concept Release on Risk Controls and System Safeguards for Automated Trading Environments, 78 Fed. Reg. 56,542 (Sept. 12, 2013), http://www.gpo.gov/fdsys/pkg/FR-2013-09-12/pdf/2013-22185.pdf.

    47 E.g., Futures Industry Association, Comment Letter on Concept Release on Risk Controls and System Safeguards for Automated Trading Environments 2–3 (Dec. 11, 2013) [hereinafter FIA Comment Letter], http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59445&SearchText=; see also CME Group, Comment Letter on Concept Release on Risk Controls and System Safeguards for Automated Trading Environments 2–3 (Dec. 11, 2013), http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=59456&SearchText=CME%20Group.

    48 See generally FIA Comment Letter, supra note 47.

    49 CFTC, Transcript: Staff Roundtable on Cybersecurity and System Safeguards Testing 5 (Mar. 18, 2015) (statement of Timothy G. Massad, Chairman, CFTC), http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/transcript031815.pdf.

    50 See Depository Trust & Clearing Corporation, Systemic Risk Barometer Study 1, 3 (2015), http://www.dtcc.com/news/2015/may/13/cyber-security-cited-as-number-one-risk-to-financial-markets.aspx (finding that market participants cite cyber-attacks as the most serious risk to financial markets); Carter Dougherty, Banks Dreading Computer Hacks Call for Cyber War Council, Bloomberg, July 8, 2014, http://www.bloomberg.com/news/2014-07-08/banks-dreading-computer-hacks-call-for-cyber-war-council.html/; John McCrank, Cyber Attacks on Stock Exchanges Put Markets at Risk, Reuters, July 16, 2013, http://www.reuters.com/article/2013/07/16/net-us-cybercrime-exchanges-report-idUSBRE96F19A20130716 (observing that approximately half of the world’s securities exchanges were targets of cyber-attacks during the previous year); see also Andrew Ackerman, Cyberattacks Represent Top Risk, SEC Chief Says, Wall St. J., May 8, 2015, http://www.wsj.com/articles/cyberattacks-represent-top-risk-sec-chief-says-1431097038. See generally Damian Paletta, Danny Yadron & Jennifer Valentino-DeVries, Cyberwar Ignites New Arms Race, Wall St. J., Oct. 12, 2015, at A1, A12.

    51 The cyber risk insurance market is experiencing rapid development, with the rise of global gross written premiums from $850 million in 2012 to an estimated $2.5 billion in 2014. Trudy Knockless, Demand for Cyber Risk Insurance Market on the Rise, PropertyCasualty360.com, Oct. 1, 2015, http://www.propertycasualty360.com/2015/10/01/demand-for-cyber-risk-insurance-market-on-the-rise.

    52 See Matt Egan, Companies Turn to Cyber Insurance as Hacker Threats Mount, Fox Business, Mar. 20, 2014, http://www.foxbusiness.com/technology/2014/03/20/companies-turn-to-cyber-insurance-as-hacker-threat-mounts/.

    53 See Anthony Malakian, Cyber Security: To Insure or Not to Insure, Waters Technology, Oct. 7, 2015, http://www.waterstechnology.com/waters/opinion/2428634/anthony-malakian-to-insure-or-not-to-insure.

    54 See Marc Lelarge & Jean Bolot, Economic Incentives to Increase Security in the Internet: The Case for Insurance, in Proceedings of IEEE INFOCOM 1494–1502 (2009).

    55 Sharon Y. Bowen, Commissioner, CFTC, Keynote Address Before ISDA North America Conference (Sept. 17, 2015), http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-6.

    56 NFA, Interpretive Notice to NFA Compliance Rules 2-9, 2-36 and 2-49: Information Systems Security Programs (2015), https://www.nfa.futures.org/news/PDF/CFTC/InterpNotc_CR2-9_2-36_2-49_InfoSystemsSecurityPrograms_Aug_2015.pdf.

    57 The SEC regulates securities markets in the United States in conjunction with FINRA, a SEC-authorized private self-regulatory organization for the securities industry. SIFMA is an industry association that represents securities firms, banks and asset managers.

    Last Updated: October 25, 2015



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