June 9, 2015
As Prepared For Delivery
Thank you for inviting me today, and I thank Simon for that kind introduction. It’s a pleasure to be here.
Just about one year ago today, I was attending for the first time a meeting of the OTC Derivatives Regulators Group in Madrid. This is the informal group of international derivatives regulators who have met over the last few years to discuss, and coordinate where possible, the implementation of reforms of the over-the-counter derivatives market.
I had been sworn into office just a couple days before. So it seemed fitting that one of my first duties as Chairman was to fly to Europe and introduce myself to my fellow regulators. As the G-20 nations implement the commitments to undertake reforms of the over-the-counter swaps market that were made at the Pittsburgh meeting almost six years ago, coordinating those reforms across borders is one of the greatest challenges.
We will observe another important anniversary next month in the U.S., which is the five year anniversary of the passage of the Dodd-Frank Act, the law that implemented those commitments. So I thought today would be a good time to talk about where we are in the effort to implement and to coordinate derivatives regulation across national borders.
To state the obvious: The success of these reforms in the years ahead depends on creating a strong cross-border framework that is as consistent as possible.
Let me turn first to the subject of regulation of clearinghouses.
On the same day I was in Madrid meeting with fellow regulators, this conference was taking place here in London. And the subject of cross-border regulation of clearinghouses came up at both.
At the meeting in Madrid, the European Commission announced that it was prepared to grant equivalence to clearinghouses in five countries. They then announced the names of the five countries. When it was apparent that the U.S. wasn’t included, I was surprised, to say the least, as were many others once the news came out.
Meanwhile at this conference, our then director of clearing, Ananda Radhakrishnan, was asked a question about whether a clearinghouse located in Europe that was clearing futures contracts listed in the U.S., and thus was faced with complying with U.S. and European law, should get an exemption from compliance with U.S. law. No, he said, they could just move the clearing of U.S. contracts back to the U.S. That caused a few eyebrows to be raised also, as you may recall.
And so began my introduction to the issue of clearinghouse equivalence.
Where are we today? Europe has not yet recognized the U.S. Meanwhile, nobody’s moved clearing of U.S. futures contracts back to the U.S., though there is occasional talk of that, and Ananda has moved to a U.K.-based law firm.
I suspect some of you are wondering, well, why is it taking so long for the U.S. and Europe to resolve this?
As I thought about my answer to that, I thought of other long international negotiations in history. There were the Paris Peace talks on ending the Vietnam War, for example. Those involved the U.S., North Vietnam, South Vietnam, and the Vietcong. As you may recall, the parties literally spent months debating the shape of the table at which they would negotiate.
So the good news is we haven’t been doing that. We have discussed these issues around a variety of table shapes and sizes. Now having mentioned that, I will probably cause someone in the press to write, “Massad compares clearinghouse equivalence discussions to international war.” Or perhaps someone who remembers the history of the Paris Peace talks will think, “Well maybe he used that comparison because the Paris Peace talks only picked up speed once a Presidential election happened in the U.S., and he’s actually signaling that you can’t expect any progress on this issue until sometime in 2017.”
Neither is true, of course. The fact is I believe we are making good progress. I expect that we will get there. Lord Jonathan Hill and I had a very good discussion last month. We sat at a small round table in case you are interested. We have resolved some issues, in particular the terms of substituted compliance in the application of U.S. law to European clearinghouses that must register with us. Our law does not require registration in all cases; it is only if a clearinghouse clears futures listed in the U.S. or clears swaps for U.S. customers. And I believe we have agreed on a good substituted compliance framework assuming we can resolve the other issues.
Moreover, I believe we have narrowed the other issues being discussed, and we have agreed to address those issues in a data-driven way – by agreeing on what analysis needs to be done to look at the potential effects of differences in our regulatory systems. In particular, we are looking at margin methodology issues with respect to futures. For those interested, I recently gave a speech to a committee of the European Parliament that describes the issues we are discussing in more detail.
I believe Lord Hill wants to resolve this soon, as I do, and we are working in good faith toward that end. I also believe we are both committed to resolving this without creating any disruption to the market, as evidenced by the European Commission’s further postponement of the imposition of capital charges.
Ultimately this is about adapting our regulatory frameworks to a new world, a world in which we recognize that because markets are global, and the swaps market in particular is highly mobile, risk can be transferred across borders easily and at the blink of an eye. It is also a world in which we have made clearinghouses more important, and therefore regulators must work together to oversee those clearinghouses. And part of what we are doing is figuring out whether differences in our respective regimes matter to the goal of fostering financial stability by creating the global framework of regulation that I discussed earlier.
There is other very important work going on in the area of clearinghouse regulation as well through international organizations. There has been substantial work done already, as you know, through the efforts of the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions, or the CPMI-IOSCO group. This is the group that developed the Principles for Financial Market Infrastructures. It has taken a variety of other actions to promote the implementation of those principles, including implementation monitoring across jurisdictions and guidance on disclosure issues.
Recently, we and many other international regulators agreed on a workplan to examine further some key issues regarding the resiliency of CCPs. This will be conducted through the CPMI-IOSCO group as well as committees of the Financial Stability Board and the Basel Committee on Banking Supervision. We will be looking at stress testing of clearinghouses, for example, and whether there should be international standards for stress testing that give us some basis to compare the resiliency of different clearinghouses. We will be looking at the adequacy of recovery planning. And we will be looking at resolution planning. While we hope that the tools of recovery or resolution never have to be used, it is important that those plans are developed just in case.
Let me turn to the regulation of swaps trading – an area that is essential to having open and transparent derivatives markets. The Dodd-Frank Act required the CFTC to implement trading rules within one year of passage of the Act. And thus the U.S. rules have been in effect now for some time. We have almost two dozen trading platforms registered with us, and we are seeing the benefits of these reforms in terms of greater price transparency, for example, beginning to be realized. But most other jurisdictions have not yet implemented their rules. Europe’s rules are due to take effect in 2017 for example.
Our implementation of rules ahead of other jurisdictions has therefore presented a challenge. In a highly mobile, global market, it comes as little surprise that traders will seek to avoid the burden of dealing with new rules, if they have a choice. So we look forward to working with other jurisdictions as their rules come on line to harmonize where possible.
Our goal is to create a framework that not only promotes transparency and integrity but also enables markets to thrive. To that end, we in the U.S. have been working to fine-tune our rules based on participant feedback and observing the new rules in practice. We have acted on a number of improvements, including steps to make it easier to execute package trades and correct error trades, and steps to simplify trade confirmations and reporting obligations. We are looking at additional issues pertaining to SEF trading as well. For example, we are planning to hold a public roundtable later this year on the made-available-for-trade determination process, where many industry participants have suggested that the agency play a greater role in determining which products should be mandated for trading and when.
We have also been working with other jurisdictions on trading issues. CFTC staff recently worked with Australian swap platforms to clarify how they can permit U.S. participation under our trading rules. One platform, Yieldbroker, recently confirmed it will adopt this approach. Our action with qualified trading platforms in Australia may provide a pathway for regulated trading platforms in other jurisdictions to allow participation by U.S. persons consistent with our rules and without having to register separately in the U.S. We are open to working with other jurisdictions and platforms on this.
Data and Reporting
We have also been focused on issues related to data and reporting. Both regulators and the public are beginning to see the benefits of greater transparency in the swaps market. But while we have much better data today than in 2008, we have a lot more work to do to get to where we want to be. The success of any reporting regime depends on the availability of high quality, standardized data. That is especially true for the swaps market. There are around two dozen data repositories globally. And there are participants around the world who must report. So, here too, cross border cooperation and collaboration are vital.
We and the European Central Bank are leading important efforts in this area. We currently co-chair a global task force under the auspices of CPMI-IOSCO that is seeking to standardize data standards internationally. We are now focused on developing standards for data elements, the Unique Product Identifier and Unique Transaction Identifier. The group expects to issue technical guidance on the UPI and UTI in July and November of this year for public review and comment. The FSB is also doing some work in this area. We support and intend to actively participate in this effort as well. While much of this work is highly technical, it is vitally important to international cooperation and transparency.
We are also taking steps at home to improve our reporting framework. Later this summer, I expect that we will propose some changes to our swap reporting rules for cleared swaps designed to clarify reporting obligations and improve the quality and usability of data in the data repositories. We are looking at other possible changes as well.
Margin for Uncleared Swaps
I want to turn now to another priority for us over the next few months, which is to finalize our proposal on margin requirements for uncleared swaps. This is one of the most important pieces of the framework for regulating the swaps market. We have made great progress requiring clearing of standard transactions. In fact, the percentage of transactions that are centrally cleared in the markets we oversee has gone from about 15% in December 2007 to about 75% today. But that is only one piece of the puzzle. There will always be a large part of the swaps market that is not and should not be centrally cleared. Some products are not suited to central clearing because of their risk characteristics, liquidity profiles and other factors. And there will and should always be innovation in the market which will lead to new products that at least initially will not be cleared. Therefore margin for uncleared swaps is essential to mitigating the risk to our financial system and the broader economy that can come from uncleared bilateral swap transactions. U.S. bank regulators are also responsible for developing rules in this area, and we are working closely with them. I should note that these rules apply to swap dealers, in their transactions with one another and with financial institutions that exceed certain thresholds. As with our clearing and trading mandates, commercial end-users are exempted.
We recognize the importance of having the uncleared margin rules of different jurisdictions be as consistent as possible. We do not want to create the potential for regulatory arbitrage or disruption in the market by creating unnecessary differences. So, we have been working with European and Japanese regulators, who are also currently considering margin rules, to harmonize our rules as much as possible. I am hopeful that they will be similar on many key issues. I would expect this to include overall thresholds as to when margin must be collected, timing of implementation, and the basic standards for initial margin models.
We are also looking at the cross border aspects of our own rules, and I would like to spend a few minutes discussing this. For example, when should the U.S. rule apply to transactions by non-U.S. persons who are registered with us as swap dealers? When should we be willing to accept compliance with another jurisdictions’ rules instead of our own – that is, when should substituted compliance be available? And when should our rules simply not apply at all?
Last September, the Commission asked for public input on three different approaches to the application of our proposed rule on margin in cross border transactions. One approach was labelled the Guidance Approach because it would apply the margin rule in accordance with the Commission’s cross border guidance on a transaction basis, with a broad exclusion for foreign to foreign trades. A second approach was called the Entity Approach, because it would apply the margin rule to all uncleared swaps of a registered swap dealer without any exclusions.
And a third approach was to conform to the bank regulators’ proposal, which was an entity based approach with two important differences. It provided for substituted compliance in many cases, and it provided a limited exclusion where neither party was guaranteed or controlled by a U.S. person.
We have received a lot of comment on these issues, discussed them internally and discussed them with the bank regulators. And although we have not yet made a decision, today I want to outline my thoughts on the different approaches.
First, the law states that the margin rules must help ensure the safety and soundness of swap dealers and be appropriate for the risk of the uncleared swaps that they hold. It also directs us and the U.S. bank regulators to try to harmonize our rules as much as possible. Finally, I believe we must take into account the supervisory interests of foreign regulators, and design our rules to reduce the potential for conflict or duplication to the extent possible.
With that in mind, I am concerned that the Guidance Approach would exclude too many transactions by non-U.S. swap dealers, because it would exclude transactions with a foreign counterparty even where the swap obligations of the dealer are guaranteed by a U.S. person. At the same time, the Guidance Approach could put U.S. swap dealers at a competitive disadvantage with foreign dealers when seeking to transact with a foreign counterparty, because it would not allow for substituted compliance under any circumstances.
The Entity Approach starts from the perspective that if a foreign swap dealer is sufficiently active in the U.S. to be required to register, then why shouldn’t U.S. margin rules be applied to all its transactions? However, this approach would not adequately take into account the supervisory interests of foreign regulators, particularly when it comes to transactions between a foreign swap dealer and a foreign counterparty, when neither is guaranteed by a U.S. person or even controlled by a U.S. person.
Therefore I support proposing an approach which is a hybrid of the entity- and transaction-level approaches. It is also an approach that is closely aligned with the approach that the bank regulators previously proposed. I believe such an approach strikes the right balance between the Commission’s supervisory interest in ensuring the safety and soundness of registered swap dealers and the need to recognize principles of international comity and reduce the potential for conflict with foreign regulatory requirements.
In thinking about what approach would be best, I have also considered the practice of what has been loosely termed “de-guaranteeing.” That is, last year, shortly before I took office, there were reports that some U.S. swap dealers were removing or no longer providing guarantees of swap transactions entered into by their offshore affiliates. The reports said these actions were motivated in part because offshore counterparties did not want to transact with U.S. dealers if that meant being subject to U.S. swaps rules. Some also suggested it was motivated by a desire among the U.S. parent entities to limit the impact of the new U.S. margin requirements.
Some reacted to this by saying that even if the explicit guarantee was removed, wasn’t there still a risk to the U.S. parent entity in the event of a default?
I asked our staff to look into these issues, and we looked at the practices of several dealers in this area.
I believe the hybrid approach I am proposing today is a good way to address this issue. It recognizes that there can be risk to a U.S. entity from a foreign affiliate even if there is no explicit guarantee, and it would draw a line as to when we should take that risk into account that is both reasonable and very bright. The line I would propose is this: if the financial results and position of the non-U.S. swap dealer are consolidated in the financial statements of the U.S. parent, then we should take that into account, whether or not there is an explicit guarantee.
The approach I would support would also provide for substituted compliance.
So how would this approach work? U.S. swap dealers would be required to comply with the rule in all their transactions, but in their transactions with certain non-U.S. counterparties, they would be entitled to substituted compliance with respect to margin they post, but not the margin they collect. Non-U.S. swap dealers whose swap obligations are guaranteed by a U.S. person would be treated the same way. Substituted compliance would be available in the case of the laws of those jurisdictions which we have deemed comparable.
For non-U.S. swap dealers registered with us, whose obligations are not guaranteed by a U.S. person, they would be entitled to substituted compliance to a greater extent. Generally, they could avail themselves of substituted compliance unless the counterparty was a U.S. swap dealer or a swap dealer guaranteed by a U.S. person. And, transactions by a non-U.S. swap dealer would be excluded from the rule only if both the swap dealer and its counterparty are neither guaranteed by a U.S. person nor consolidated in the financial statements of a U.S. person. The limited exclusion available – which applies only if neither party is guaranteed or consolidated with a U.S. person – helps address the concern that there is risk to the U.S. even if there is no explicit guarantee. The broader scope of substituted compliance recognizes that we must work together with other jurisdictions to regulate this market, and we should design our rules to avoid conflict and duplication as much as possible. And the way in which substituted compliance is made available may reduce competitive disparities that can otherwise arise from different sets of rules applying to swap dealers engaged in essentially the same activity.
Let me make clear these are my own views. We are still discussing this internally as well as with the bank regulators, so you will have to wait a bit longer for anything further. I would note that I have omitted many details. For one thing, I have referred to swap dealers, but as with the base rule, it would apply to swap dealers and what we call major swap participants in the same way. Finally, I am suggesting that we propose such an approach and invite public comment on it.
Let me conclude on this note. I have occasionally said that cross-border harmonization of derivatives regulation is one of those issues where some see a glass half empty, and others see a glass half full. Those who see the glass half empty point out the differences that exist today between the approaches to these issues that are being taken in the U.S., Europe, or Asia, and insist that these must be harmonized. But I believe they start from an unrealistic perspective. It is a perspective shaped by the fact that this was a global market before it was regulated. Therefore participants did not have to think about whether there were differences in national laws that might affect transactions. That is unlike what goes on in most markets.
The fact is we are still a world where individual nations – or a union of nations – write the laws. Individual nations have their own legal traditions, regulatory philosophies, and political processes that shape those laws. In every area of financial regulation that I know of, there are differences, often very significant differences, in national laws and regulations. There will be differences here also.
And so I see a glass half full. We have achieved a great deal of harmonization already. And we will achieve more in the future. It takes time, it requires us continuing to work in good faith.
It’s helpful to remember the early days of this industry. I was very involved then, helping to write the original standard forms. That took time. And it took years to establish that the netting of multiple transactions under a single master agreement would be recognized under the bankruptcy laws of different jurisdictions.
So harmonization, where possible, will take time, but I am personally committed to the goal. At the CFTC, we look forward to continuing to work together with our regulatory counterparts around the world, as well as with market participants, on these important efforts.
Thank you again for inviting me to discuss these issues with you today. I welcome your thoughts and questions.
Last Updated: June 10, 2015