April 23, 2015
As Prepared For Delivery
Thank you for inviting me today, and I thank Eric for that kind introduction. It’s a pleasure to be here.
It is thirty years since ISDA was created, and thirty years ago I was a young associate at the firm that did the legal work to create ISDA. And at that time I got involved in a project that consumed the next couple years of my life. As some of you know, I was part of a small group of lawyers and bankers who drafted the original ISDA standard forms – a U.S. law form and a U.K. law version. There were endless meetings to try to get the two forms to be as similar as possible – a precursor of sorts to today’s cross-border harmonization efforts. Diane Genova, the treasurer of ISDA, was in all those meetings.
Ultimately we got the job done. And I don’t think any of us could have predicted just how important that process would be. Those forms, coupled with the other pioneering work done to create standards and consistency – such as the process for establishing that netting of swaps would be respected under bankruptcy law around the world – created a foundation for the growth of a global industry.
Back in those days, never would I have guessed that decades later I would be standing here, as the chairman of the regulatory agency with the leading role in regulating this market, a market that is now measured in the hundreds of trillions of dollars.
The timing of my remarks is also significant in another respect. In addition to this year being the thirtieth anniversary for ISDA, this year, and indeed this past Tuesday, marks the 40th anniversary of the CFTC. The agency was formed as a separate entity on April 21, 1975, having been part of the Department of Agriculture prior to that time.
The occasion of our 40th anniversary underscores the dedication and hard work of the agency’s staff. Needless to say, everything that our agency has accomplished is a credit to their tireless efforts. I also thank my fellow commissioners for their efforts, particularly their willingness to work constructively together. We may not always agree, but I know that we are all committed to making sure our markets continue to thrive and work for the many businesses that rely on them.
And while I am on the subject of cooperation and collaboration, I want to thank our regulatory colleagues in Canada. In particular, we have had excellent ongoing relationships with Louis Morisset and his staff here in Quebec, as well as Howard Wetson and his team in Ontario. And I also want to thank Howard for his work as a Vice-Chairman of IOSCO.
The derivatives markets have become integral to the growth of the global economy by enabling businesses of all types to manage risk. But as we learned in the fall of 2008, these markets can create significant risks as well. The build-up of excessive risks that were not well known or understood contributed to the intensity of the global financial crisis – the worst since the Great Depression – one that cost eight million Americans their jobs.
And so we are engaged in creating a new regulatory framework for that market, and we have made great progress. The percentage of cleared transactions in our markets has increased dramatically – from around 15 percent in December 2007 to approximately 75 percent today. This enables us to better monitor risk, as well as reduce it through compression and other efforts. We have implemented oversight of swap dealers. We have implemented a framework for making swap trading more transparent. And through our data collection efforts, we know far more about what is going on in this market than we did at the time of the crisis. There is more work to be done in all of these areas, but I see many parallels to the securities reforms launched in the 30’s and 40’s, and I believe we will look back on our current reform effort similarly: that is, today as then, we are putting in place a sensible framework built on the principles of transparency and market integrity.
Our Priorities and Recent Progress
Today, I want to discuss some of the issues on our agenda for the months ahead. Let me summarize some of our priorities briefly and then turn to some specific issues. First, we have been fine-tuning our rules in a number of areas to address concerns of commercial end-users, because it is essential that, as we implement this new framework, commercial companies can continue to use the derivatives markets effectively to hedge commercial risk. This has included adjustments to reporting requirements and measures to facilitate access to these markets by end-users. We will continue to look at these types of issues in the future. A second priority has been to finish the few remaining rules mandated by Dodd-Frank, such as margin and position limits.
We are also focused on harmonizing rules with other regulators – domestic and international – as much as possible. We are working hard on improving and standardizing the data collection and analysis efforts as well.
And we remain committed to a robust enforcement and compliance program to prevent fraud and manipulation.
This has been an active week for the CFTC. Just this morning, the agency along with our colleagues at the Department of Justice, the Financial Conduct Authority and New York’s Department of Financial Services announced a settlement with Deutsche Bank over charges of manipulating their LIBOR submission. With today’s action, the CFTC has imposed over $4 billion in penalties against 13 banks and brokers to address LIBOR and FX benchmark abuses. Today’s settlement also represents the highest fine in the agency’s history. In addition, earlier this week, the Commission and the Department of Justice brought civil and criminal charges against an individual whose actions we believe contributed to the market conditions that led to the flash crash of 2010. We worked closely not only with the Justice Department, but also the FBI, the U.K. Financial Conduct Authority and Scotland Yard on this case. As these cases illustrate, we will do everything in our power to pursue those who attempt to engage in fraud or manipulation in our markets. There is nothing more important than the integrity of our markets.
Let me turn now to highlight a few of the items on our agenda for the coming months in two categories: issues pertaining to clearing and risk, and those pertaining to trading.
Clearing and Risk
Clearinghouse oversight continues to be a chief priority. In this post-global financial crisis world, clearinghouses play an even more critical role than before. So we need to make sure clearinghouses have strength and resiliency. Last month, I spoke at length about our overall framework for clearinghouse oversight and the actions we have taken in the last few years to strengthen this. I also noted the work we are doing on recovery and resolution planning both domestically and internationally. These issues are high on our agenda. I also noted the importance of cybersecurity. This applies to key exchanges and other critical infrastructure as well as clearinghouses. We have incorporated cyber concerns into our core principles and made it a priority in our examinations. Our challenge is to leverage our limited resources as effectively as possible. Many major financial institutions are spending far more on cybersecurity than our entire budget. We do not have, for example, the resources to do independent testing. So we have been looking at whether the private companies that run the core infrastructure under our jurisdiction – the major exchanges and clearinghouses for example – are doing adequate testing themselves of their cyber protections, such as control testing, penetration testing and vulnerability testing. Commission staff held a roundtable to discuss this issue last month, and received very useful input. I expect that we will propose a new rule on this subject later this year, which would set forth requirements on testing to insure that best practices are being followed.
Another priority related to clearing and risk is finishing our rule on margin for uncleared swaps. This rule plays a key role in the new regulatory framework because uncleared transactions will always be an important part of the market. Certain products will not be suitable for central clearing because of their lack of sufficient liquidity or the presence of other risk characteristics. In these cases, margin will continue to be a significant tool to mitigate the risk of default from those transactions and, therefore, the potential risk to the financial system as a whole.
As you know, we reproposed a rule in September of last year. We are currently working with the bank regulators to finalize these proposed rules by the summer, and to achieve as much consistency between our respective rules as possible. These rules exempt commercial end-users from the margin requirements, consistent with Congressional intent.
In addition to harmonizing with the U.S. bank regulators, we are also working with regulators in Europe and Japan who are formulating rules on margin. I am hopeful that our respective final rules will be similar on most issues.
We also continue to engage with the European Commission and ESMA on whether they will recognize our clearinghouses as equivalent. We have agreed to a substituted compliance framework to address what was their principal concern. We believe there is an ample basis for an equivalence determination.
Implementing the Framework for Swaps Trading
Let me now turn to discuss swaps trading. It has been a little over a year since the first made available for trade determinations. We currently have almost two dozen swap execution facilities.
A recent ISDA report highlights some positive trends. Measured by trade count and notional value, SEF trading accounted for about half of total volume in 2014. For swaps on CDS indices, roughly two-thirds of trades were transacted on SEFs. Regarding interest rate swaps, the picture is more nuanced. Against a backdrop of low or even negative interest rates, overall volumes have fluctuated both on and off SEFs. As for participation, one SEF recently confirmed that it had exceeded 700 buy side firms as participants. We have also seen a significant increase in non-U.S. market participants participating on SEFs for credit indices, now at about 20 percent from negligible levels this time last year.
At the SEFCON last fall, I discussed the purposes of the trading mandate, which include bringing greater price transparency and promoting competition. I said our goal should be to build a regulatory framework that not only meets the Congressional mandate of bringing this market out of the shadows, but which also creates the foundation for the market to thrive. The regulatory framework must ensure transparency, integrity and oversight, and, at the same time, permit innovation, freedom and competition.
I believe all of the Commissioners share this goal, and we have had good discussions internally about how we might better achieve these ends.
I want to note in particular the efforts of Commissioner Giancarlo. He has written a very thoughtful white paper about SEF trading. Chris’s experience in the marketplace is of great value to us at the CFTC, and we are lucky to have him. Although I do not agree with his suggestion that we should throw out the rules and start over, I believe we can find common ground on changes that will improve the framework.
Last fall, I promised that we would look for ways to improve the regulatory framework, to fine tune our rules so as to enhance trading. Yesterday, at the DerivOps conference in Chicago, I outlined some of the actions we have already taken, and several new steps that we are currently taking, to improve the operational aspects of SEF trading. I want to quickly review those today, and then discuss some additional matters that we are looking at.
Yesterday, I announced a few additional operational steps we are taking to make the new trading framework more effective, efficient, and attractive to participants. These include:
In many of these areas, staff believed it was in the interest of the market to provide at least temporary relief or an adjustment through no-action letters. This gives the market time to develop solutions, and in some cases, the staff will explore possible amendments to Commission rules to address issues through a rulemaking as well.
Let me turn now to some additional issues concerning SEFs that we are looking at.
The first is the issue of whether trading of certain swaps should be required to be anonymous. This is an issue I am very concerned about, particularly with respect to trades taking place on a central limit order book that are then immediately cleared. We have heard market participants express concern about potential negative consequences of this practice with respect to its effects on liquidity and participation, and I have not heard a compelling justification for it. Now some say the market will, or should, address this on its own – if there is sufficient demand for anonymous execution, or when the market is ready, it will happen. But some market participants have also expressed the view that no individual SEF can afford to be the first to prohibit name give-up practices in the absence of action by us, because of potential retaliatory action by other market participants.
In light of that, I am discussing with my fellow Commissioners possible actions, and I expect that we will have more to say on this in the future.
Flexibility Regarding Methods of Execution
Another issue we are looking at is to make sure there is some flexibility in methods of execution as long as our regulatory goals are met. While our rules specifically refer to using a central limit order book or an RFQ to 3 trading protocol for Required Transactions, the Commission noted in adopting the rule that additional execution methods might be acceptable.
In recent months, our staff has been engaged with certain SEFs regarding an auction match trading protocol. Staff has confirmed with these SEFs that this mode of execution is acceptable as long as their rulebooks provide adequate transparency regarding the process for setting the offer price. . We will of course monitor the platforms that offer this protocol to make sure that it is not leading to abusive practices.
SEF Financial Resources
Another area pertains to the capital that SEFs must hold. The law requires that SEFs hold capital equal to one year’s operating expenses. Today, our staff is issuing guidance that will clarify the calculation of projected operating expenses for this purpose. Specifically, the guidance will clarify that while fixed salaries and compensation must be included in projected operating expenses, the staff’s view is that the variable commissions that SEFs might pay their employee-brokers do not have to be included in a SEF’s calculation of projected operating costs. That is because the commissions are not payable unless and until associated revenue is produced and collected.
I also believe we should take a look at the made available to trade or MAT determination process. The framework we have in place today is modeled after the process followed for product innovation in the futures markets. But some have suggested that the CFTC should have greater authority over which products are subject to MAT determinations, perhaps by having the power to delay a determination initiated by a market participant or the power to initiate a determination. Therefore, I have directed the staff to convene a public roundtable to obtain views and comment on these important issues, and then we can consider whether to take further action.
The changes I have discussed today are the type of fine-tuning that the agency needs to be engaged in as the Dodd-Frank rules take effect. These changes provide temporary relief, or make operational and other adjustments that do not change the fundamental framework, but rather help us achieve it better. The changes I have mentioned are also not meant to be a final list. We are continuing to consider what types of changes can help achieve the goals I outlined earlier for SEF trading, and we welcome the public’s input on these matters.
We are also focused on the cross-border implications of our trading mandate rules. This has been one of the greatest challenges. We were among the first to implement swaps trading rules and to mandate trading of certain products; many other jurisdictions have not yet done so. To avoid the potential for any regulatory arbitrage, we look forward to others adopting their own rules to implement swaps trading as well as the other G-20 commitments, and we look forward to working with them to harmonize rules as much as possible.
I want to conclude my remarks today by noting the issue of resources. As you all know, well-working markets depend on good regulation and oversight, and that requires resources. In my view, our current budget falls short. We are stretched too thin. We are not able to process SEF registration applications or consider adjustments to rules as quickly as we would like. We are less able to respond to market participants’ concerns. We are limited in our ability to examine clearinghouses, exchanges and other infrastructure and to address emerging concerns such as cybersecurity. And our surveillance and enforcement capabilities are reduced.
The simple fact is that, without additional resources, our markets cannot be as well supervised; participants cannot be as well protected; market transparency and efficiency cannot be as fully achieved.
I continue to believe that the United States has the best financial markets in the world. They have been a significant engine of our economic growth and prosperity. Good regulation is necessary to keep them that way. I look forward to working with you as we move forward.
Thank you again for inviting me today.
Last Updated: April 23, 2015