October 16, 2014
Thank you for inviting me to speak here today, and I thank Congressman Richard Baker for that kind introduction. I also want to acknowledge the work that the Managed Funds Association and its members have done. We appreciate your input on all of our issues and look forward to continuing to work with you.
It was about a year ago when I was first nominated by President Obama to this position.
I am happy to share a few of my views. My perspective is shaped by two sets of experiences. The first is the five years I spent immediately prior to this job helping our nation recover from the worst financial crisis since the Great Depression. That experience makes it easy to remember why we are implementing reforms of the derivatives market in the first place. We must never forget the true cost of the crisis: eight million jobs lost, millions of foreclosed homes, countless retirements and college educations deferred and businesses shuttered.
My perspective is also shaped by my work as a lawyer in the private sector for 25 years before joining Treasury. I worked with businesses and governments all over the world on all types of transactions. And as a young lawyer, I was part of a small group that drafted the original ISDA master agreements in the late 1980s as well as related documents such as the code of definitions and the user’s guide. I then went on to advise clients periodically on derivatives matters. And so I appreciate the importance of these markets to a wide variety of businesses. As we implement this regulatory framework designed to protect against excessive risk, we must make sure these markets continue to work effectively for the many businesses that depend on them to hedge routine risks.
Let me just highlight some things we are doing in two areas that I consider priorities—fine tuning the rules, and cross border harmonization.
As you know, the CFTC has written most of the rules mandated by Dodd-Frank. And now we are looking at some clarifications and adjustments to make sure the rules work as intended. This is to be expected with reforms as significant as these.
Part of that task is to make sure our rules do not impose undue burdens or unintended consequences on the nonfinancial commercial companies who rely on these markets, whether they be manufacturers, farmers, ranchers, or other companies. They were not responsible for the crisis or the excessive risks that have come out of this market. So how are we doing this? We have done so with respect to our reproposed rule on margin for uncleared swaps, one of the most important remaining rules which we proposed last month. This exempts end-users from the requirements. We worked closely with the bank regulators so that our respective rules on this subject are quite similar, and on this particular point, we got them to move to our position. We have also addressed end-user concerns recently with respect to an amendment to our rules dealing with the ability of many local utility companies to access the energy swap market. We are also looking at some other issues of concern to commercial end-users, such as contracts with embedded volumetric optionality and certain record keeping obligations, and I expect that we will take action on some additional matters before year end.
A second area I want to touch on is cross border harmonization. I know many market participants are concerned about potential harm if the derivatives reforms adopted by different jurisdictions are not the same. I share the concern. But let’s step back for a moment. How many of you expect the rules as to how you sell securities to be the same in all the G-20 nations? If you have worked on a public offering, you know they are not. Or how about the rules for securing bank loans? Those aren’t even the same in the 50 states. So let’s remember that we are in a unique historical situation: the OTC derivatives industry grew up to be a global industry without any regulation. Now we are seeking to regulate it through the actions of the various G-20 nations, each of which has its own legal traditions, regulatory philosophy, administrative process and political dynamics. There will inevitably be differences. But I regard this as a glass half full, not half empty. We are making progress, but it will take time.
We issued substituted compliance determinations for many aspects of our rules last December. We will do more in this area, but that requires other jurisdictions to get their rules done so there is something to compare to.
Let me say a few words in particular about cross-border harmonization when it comes to the regulation of central clearinghouses. The European Union has not yet recognized our central clearinghouses as equivalent—indeed they have not yet issued any equivalence determinations. I believe they should. Our clearinghouses meet the international standards. They believe that in order to recognize our clearinghouses, changes are needed in our treatment of clearinghouses that are located in Europe but are also registered with the U.S. Now, we have had dually registered clearinghouses for many years. That’s because the U.S. did not mandate that clearing of futures—even futures traded on U.S. exchanges—take place in the U.S.; we simply required that it take place at clearinghouses that are registered with us and that meet our standards. Those standards tie in to our bankruptcy laws. They provide protection of customer funds and facilitate quick transfers of customer accounts in the event of a failing firm—transfers that are protected under bankruptcy law. We have seen this work in MF Global and Lehman most recently. We built our swap mandates on this framework of dual registration, and as a result, clearing of swaps for Americans largely takes place overseas. One European clearinghouse, for example, has been dually registered since 2001, and it handles most of the market for swap clearing, and a majority of that clearing is for US persons.
The dual registration regime has worked. Moreover, this is a good approach because central clearinghouses are even more important in the global financial system today as a result of the global reforms to the OTC swap market. And therefore regulators must work together to make sure clearinghouses operate transparently and do not pose risks to financial stability.
Nevertheless, to facilitate the Europeans’ recognition of our clearinghouses, we have agreed to look at whether we can further harmonize our rules, and we are continuing to work on these issues with the Europeans. I am pleased that European Commission has decided to postpone the imposition of higher capital charges on European banks participating in our markets. It was this threat of higher capital charges that was going to fragment the market, not the existence of dual registration, which has actually been the foundation for the growth of the global market.
With that, I will end my introductory comments, and begin the conversation with Darcy.
Last Updated: October 17, 2014